Portfolio Insurance: A New Spin on Wealth Creation

Howard Kaye

For some of our clients, investing in the stock market isn’t just a financial planning strategy. It’s a way of life. They enjoy investing, and they don’t want to give it up just because most financial planners tell them to reduce their risk as they age. They want to keep going with the stock market. Luckily, there are ways to reduce your investment risk without pulling out of the market. One way is to use life insurance as a form of portfolio insurance.  

Why You’re Supposed to Reduce Your Risk as You Age

Any investor knows the old rule of thumb in portfolio allocation. As you age, you’re supposed to reduce your overall percentage of riskier strategies while increasing your percentage of safe investments. This is to ensure that if you suffer a loss in the stock market, you’ll be able to make it up with more stable investments. You’ll be less impacted by short-term losses.

But what if you’re happy with the way your portfolio is performing, and you want to keep going with it? What if you just like investing? Just because you’re getting older does not mean you have to put all of your savings in money market accounts or municipal bonds. Instead, you can use other methods of managing your portfolio that don’t involve going entirely conservative.

Various Options for Protecting a Portfolio

There are a few ways to protect a stock portfolio with high-risk investments in it, which don’t involve simply selling off high-risk assets. Most of these are tactics that need to be actively managed and require a bit of investment know-how. While we are not licensed to offer securities or other investment options, we want to be sure you are aware of the most common approaches, which are widely known.

One way that some investors with a stock-heavy portfolio go is to match stocks up with “put options.” A put option is kind of like a bet that a stock value will decline. A put is a contract that allows you, the stock owner, to sell your shares for a specific amount in the future.

Just like a stock, these put options can be sold, and if the stock value goes down in the future, the value of these put options will go up. They have an inverse relationship to the underlying stock. If the stock goes up, you don’t have to exercise your put option. If the stock goes down, you can sell your put option for more money.

Another option is to set up “stop-losses” for a specific stock. This creates a bottom line, and if your stock reaches that point, it will automatically be sold to prevent further losses. So you buy a stock for $20 and set a stop-loss at $15. Then, you can rest assured that no matter how much the stock drops, the maximum amount you’ll stand to lose is 25% of the initial value.

Of course, both of these involve using short-term strategies to protect against long-term losses. The issue here is: What if you don’t want to change your portfolio, or you don’t have the time to actively manage it? In that case, you can use permanent life insurance as a method of risk management.

New Thoughts on Portfolio Insurance

Using life insurance as a way to guarantee your portfolio offers two benefits. First, it protects heirs from major losses in your stock portfolio. Second, if your portfolio doesn’t see any losses, your family members will get your tax-free death benefit on top of your high-performing portfolio.

Life insurance works for this because it’s a risk management tool. It’s not an investment, so you won’t have to worry about it losing value if the stock market goes down. In a way, it’s a non-correlating strategy. You’re using something not impacted by the ebbs and flows of the stock market to hedge against the risk in the stock market.

It’s also a relatively simple option. Here’s how it works. You take a look at the overall value of your higher-risk assets. Then, you buy a permanent life insurance policy that mirrors the value of those assets. This is something that would best be accomplished with a universal life insurance policy because you can increase or decrease your death benefit and policy premiums as needed.

In the event that you lose a significant amount in the stock market, you’ll have the policy there to protect your legacy and make up for those losses. It’s a simpler option than using other portfolio strategies because you’re purchasing life insurance as a means of portfolio insurance, and you don’t have to change your portfolio to do it.

Someone who uses this option will be best served using it through a trust. An irrevocable life insurance trust can be funded using your annual gift tax exclusion of $15,000 per beneficiary per year, and will allow you to hold the funds outside of your estate. This will lower your overall estate tax burden, which will be necessary if your stock portfolio performs very well. This way, your family will get the tax-free benefit of your life insurance policy, while also enjoying the strong performance of your portfolio.

While the rule of thumb might tell you to sell off your high-risk assets when you’re older, using life insurance to hedge that risk is sometimes a more appealing option. Contact a Howard Kaye advisor at 800-DIE-RICH to see how life insurance can become your form of portfolio insurance.

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