How Investors Can Use Insurance to Reduce Risk

Investors have various ways to reduce risk – diversification, cash reserves, planning to hang tough through the dips. But experts say it pays to think outside the investing box and consider other tools, like insurance.

"As we amass more assets, we have to protect those assets," says John Grace, president of Investor's Advantage Corp. in Westlake Village, California.

Needs change over time, he says, as young investors need to protect children, while older ones must safeguard retirement income and a spouse. So assessing insurance needs is a lifetime project.

Some insurance products are designed for investing. Annuities can provide income just like a portfolio of bonds and dividend-paying stocks, but with less risk. And some permanent life insurance policies like whole and universal life build cash value that can be tapped for emergencies or retirement.

But plain vanilla insurance like homeowners and auto policies have a key role too, by reducing the danger of big unexpected expenses that otherwise might be paid out of the college or retirement fund.

The trick is to be sure all the insurance products mesh with the investing strategy. If you know, for instance, that a deferred annuity will start providing income when you're 85, you might be able to spend more of your nest egg before then. You might opt to play it safer with your ordinary investments since growth wouldn't matter as much, or to gamble in hopes of leaving more to heirs, since the annuity would provide a safety net.

Options and futures. While these contracts are not really insurance products or suitable for amateurs, investors should know that it's possible to insure against loss with securities that will gain value as prices fall. Put options, for example, are contracts giving the investor the right to sell a block of shares at a given price over a set period – today's, for instance, even if the price drops over the next few months.

Puts and futures are available on many stocks and exchange-traded funds as well as indexes representing the broad market or portions of it. Options and futures are very tricky and the beginner is wise to start small.

Annuities. These are insurance products that, in their most useful form, pay a fixed income for life in exchange for a lump sum up front. They're more generous than bonds because the payment is not refundable and the insurer knows many buyers won't live to collect much if anything. Immediate annuities start paying right away, deferred ones pay more but don't start until a number of years have passed.

"Annuities do make sense for retirement purpose, because with mortality coming down and longevity getting improved, there is always fear that people may outlive their savings," says Yogesh Shetty, CEO of Avibra, an internet insurer.

But annuities do have critics. "I don't have annuities in my own investment portfolio, so I don't suggest them to my clients either," says Jimmy McMillan, owner of Heart Life Insurance and HiBMI.com online independent life insurance agencies. "The fees alone should make an investor wary... The insurance company will charge you a premium fee to put the money in, then charge you crazy surrender fees if you pull your money out for the first decade or so."

Term life insurance. Simple term policies are very cheap and pay a death benefit if the policy holder dies within a specified number of years, typically 10 to 20. They can protect a spouse or children if something happens to you. But you don't build up any value.

"Term is generally a good fit for those who have a temporary insurance need that will diminish as they age, such as providing for a young family, paying off a mortgage or having funds for retirement," says Kurt Rossi (JB), CEO of Independent Wealth Management in Wall, New Jersey.

Permanent life insurance. These come with investment features, using part of a much larger premium for funds or other holdings that grow over time and can be drawn for expenses. Unlike term policies, the death benefit is good no matter how long the policy holder lives.

"For those looking for coverage that may last for their lifetime with the option to build cash value, policies like universal life or whole life may provide a possible solution," Rossi says. "The permanent nature of these policies also makes them an effective tool for estate planning purposes to offset tax liability. However, they may be too expensive to rely on for your entire coverage needs."

Because premiums can be so high, Rossi and many other experts say it can be more profitable to get a cheap term life policy and invest the premium saved in standard holdings like mutual funds.

But investors should shop carefully, as it can be difficult to weigh the investments among different cash value policies. Also watch for high fees that can eat into returns.

"A home pool party could turn tragic in a matter of minutes, or a neighbor child might find the same pool inviting when no one is home," says John Espenschied, owner of Insurance Brokers Group in Chesterfield, Missouri. "Sympathy for the family that lost a child could easily force you into bankruptcy without proper insurance coverage."

A $1 million umbrella policy may cost as little as $300 to $400 a year, he says, and will pay out after other liability coverage, such as auto or homeowner's, is depleted.

"Umbrella insurance will give you the added peace of mind that years of investing and savings will not disappear overnight."

Informational Source