DIVERSIFICATION: A Unique Asset Class that Never Goes Down
In this post, we begin with a high-level introduction to a unique asset class that behaves very different from traditional portfolios in the areas of (1) risk and return, (2) taxation, (3) liquidity, and (4) distribution of wealth to subsequent generations. We have added some commentary on the equity and fixed-income investment markets for contrast, and plan to make further detail available in subsequent posts and conversations about how this asset may work for you.
Not all financial institutions are able to offer this unique asset class, given that recommending it involves holding a separate license. As Advisors with Freedom 55 Financial, we share this information and planning solution with you, so that you may also take advantage of its many distinctive characteristics and benefits.
Depending on your goals, be they personal or corporate, this unique asset class may just be the most meaningful investment decision you ever make.
Here is where we would like to ask you these few questions:
What if there were an asset class that you might qualify for that would never go down in value, regardless of what the stock markets are doing?
What if this asset class could be either personally or corporately held?
What if there were an asset class that was a legal tax shelter for excess investable dollars to diversify beyond your RRSP, TFSA, and primary residence?
What if there were an asset class that offers both the opportunity of accumulation of tax-advantaged cash values, which can supplement your lifestyle while you are alive, and protection for your family and business when they need it most?
Since we believe that predicting the short-term ebbs and flows of the stock market is futile, this may lead to stress and anxiety within our investment plan.
Is there a financial planning option that offers stability, guarantees, tax-effective growth of our investable dollars, and a sound alternative to traditional fixed-income investments?
Yes, there is, and it is called Participating Whole Life Insurance.
Before we dive into the full details, the below graphic may provide an initial understanding as to where Participating Whole Life Insurance fits with the other planning you may have done. In the visual graph below, you will notice that this asset class encompasses both Accumulation (generally, what investments aim to do), and Protection (what insurance does).
The Stock Market:
Have you ever timed the markets perfectly, having bought at a low and sold at a high? Me neither.
While we all love buying things on sale, human nature generally is challenged by this concept when it comes to the stock markets. Those of us who have money invested in equity markets enjoy the growth days, watching our values increase quickly over time. Over the long run, based on historical data, we know that investment markets generally move in an upward trajectory with periodic downward cycles, as shown in the figure below.
Growth of $1,000 since 1935, compared against 7 asset classes. Chart courtesy of Investments Illustrated.
But those of us who have money invested in equity markets also have seen declines in the values of our portfolios.
The End of the Bull Run:
Categorically, on March 11th 2020, the longest ever Bull Market came to an end (March 9, 2009 to March 11, 2020). However, do you think that this recent drop was truly a massive end of cycle, or just a very short-term correction? It certainly was shocking, and even more shocking – it was followed by the most fantastic bounce-back; markets rose from the ashes as quickly as they imploded! Is this current market situation a Bull within a Bear? Your guess is as good as mine.
Timing of the markets is not easy (not possible?), but we generally know that these periodic declines are inevitable, and if our planning is sound, we are able to ride them out. There is certainly a large place for higher-risk equity and lower-risk fixed-income investments in our overall net worth, and certainly within our RRSP and TFSA accounts.
This raises a few important questions, though:
What happens if you need to redeem your investments at a low point and you lock in your loss?
What if a loved one passes away and you are to receive an inheritance, which is liquidated during a down market?
What if you panic-sell because… COVID-19?
Life Insurance 101:
As a backgrounder, let's review the specific differences between Term (temporary, rental) Life Insurance and Participating Whole Life Insurance. One’s need for life insurance changes over time and often someone will end up with multiple policies each serving different purposes (maybe even a combination of Term and Permanent coverage, as shown in the diagram below).
Many high net worth individuals recognize the value of Participating Whole Life Insurance, and there is no reason for the majority of us not to do the same. The people (and organizations) that invest in this asset class realize the value of both the 'living benefits' (tax-sheltered cash values), as well as the permanent tax-free death benefit.
"If it wasn't for the cash values in my life insurance policies the bank may have decided against granting me the necessary capital to begin my first business endeavour.
I am certainly an advocate of life insurance as a vehicle to help a young person take advantage of business opportunities that may present themselves in the future."
Jim Pattison, May 12th, 2016
Below is a compilation of some of the potential advantages and disadvantages of an investment in Participating Whole Life Insurance.
The Advantages of Permanent Whole Life Insurance within your Portfolio:
Guaranteed growth of the cash value on a tax-preferred basis. When your policy's cash value grows every year, the new total is automatically guaranteed (vested) and is protected from declines, unless you use it for some other purpose.
Reduced paid-up options, which allow for flexibility if a policy-owner decides they cannot fund it anymore.
No requirement to liquidate (and subsequently pay taxes on the income), like there is with the RRSP.
Flexible access to the cash value while living. Depending on your needs at the time, there are three main ways that you can access the cash value in your policy, including: (1) directly withdraw the dividends, (2) borrow directly from the policy (as in the Infinite Banking concept), or (3) use the policy as collateral for a third-party loan.
Tax-free death benefit to named beneficiary. This is by far the most efficient and tax effective method of transferring wealth down through generations.
The Potential Disadvantages of Permanent Whole Life Insurance within your Portfolio:
Commits dollars that might otherwise be used for other investments, capital projects, or cash flow requirements. Note that implementation of an Immediate Financing Arrangement (IFA) may provide a solution to this issue for high net worth business owners.
Not everyone can qualify, as it is ultimately life insurance. If you would like this asset in your holdings, let's discuss an application for coverage.
Where does Participating Whole Life Insurance Fit in your Net Worth?
Diversification of our net worth is an elementary concept in financial planning. Applied in many elements of our life (food consumption, friendships, activities, etc.), it is also very important to apply diversification in the planning we do with our investments.
In reality though, it is not uncommon for some people to have more commitment to one asset class than another (Real Estate is a good example), but we also know that different asset classes react in their own ways to various market fluctuations. Each asset class may vary in terms of the perceived risk and potential return (and other variables), and therefore the most effective growth strategy is to allocate portions of our net worth into a number of asset classes and investments.
The below diagram shows these different asset classes ranked from high though low on the range of perceived risk, and includes a few points about their liquidity and taxation attributes.
Image courtesy of Canada Life.
And more specifically, the below images shows where Permanent Whole Life Insurance fits; it may be considered an element of the fixed-income portion of your overall investment portfolio (despite behaving differently than traditional fixed-income investments). This is certainly a general rule of thumb, since many individuals and corporations have no need to hold equity investments (in other words, they are not interested in investment risk, they have more money than they need, and intend to pass it down to future generations).
Where Permanent Whole Life Insurance fits in your portfolio.
In addition to the variables of (1) risk and return, investors and their advisors should also consider (2) tax treatment on growth and disposition, (3) liquidity and accessibility of the investment dollars, and (4) efficiency and privacy of distribution at policy annuitant's death.
When we recommend Participating Whole Life insurance to our clients, it is so that they receive the unique benefits of the policy, and to complement the rest of the planning they have done.
Here is a table showing four different asset classes and how they can be used to your advantage within your Financial Plan:
Summary of my Thoughts on Participating Whole Life Insurance:
As investors, we can be overwhelmed with the investment options that we have. Often, investing can be a stressful task, given the volatility of the financial markets, and uncertainty of what may happen to our investment. With Participating Whole Life Insurance in your holdings, you can rest assured that your policy is going to do what it promises: that is, (1) provide for vesting of dividends every year, so that the cash values only go up, as well as (2) provide a guaranteed permanent tax-free death benefit that will be there when your family or company needs it the most.
Successful business owners are not required to set up corporate structures, holding companies, family trusts, or even wills. But they do these smart things because they make sense in every way.
So…, does owning Participating Whole Life Insurance also make sense for you? The truth is, you likely don't really NEED to own it, but I expect that you will WANT to own it because of the many advantages that it will provide for both your family, and your corporate tax planning.
Let's have a conversation about how Participating Whole Life Insurance might fit in your portfolio.