It’s Time to Change the Focus of ‘Buy Term, Invest the Difference’ Arguments
If you have spent much time listening to financial pundits, you are probably familiar with the phrase “buy term and invest the difference”. This hotly contested concept has been widely discussed in the financial industry for years.1
Proponents of this strategy believe that you should purchase a term policy, then invest the difference in premium between that term contract and an equivalent permanent policy. The belief is that eventually the investment account will surpass the policy death benefit, at which point your clients will no longer need life insurance. This point in time is typically assumed to be at retirement.
Opponents of the strategy often indicate the ‘buy term invest the difference’ strategy could work in theory, but often does not actually perform as designed. They point to statistics that indicate most Americans fail to consistently invest. For example, the 2017 Retirement Confidence Survey by EBRI (Employee Benefit Research Institute) found that a large percentage of workers reported they had virtually no savings or investments. Excluding the value of their residence, 24% indicated they had less than $1,000, and 47% reported the total value of their savings as less than $25,000. This might be why one commentator suggested that the ‘buy term, invest the difference’ could more accurately be called “buy term, lapse it, and not invest the difference”. Opponents also point out that it’s not accurate to use average market returns in economic modeling because studies show that the average investor usually lags behind the market performance.2
This debate has not waned over the years, and neither side of the argument has yet to persuade the other.3 The stalemate is likely to continue so long as the focus is based on economic modeling. For this reason, it is time to change the focus of the argument to one that stresses features instead.
In a seminal study published in 1982, Ohio State University professor Michael Smith noted that permanent life insurance gives consumers options that cannot be duplicated by any other financial product4 and this is especially true today. A sales idea recently came across my desk that demonstrates some of these options available on a permanent life insurance policy.
Case Example
Jim and Sue purchased a policy at age 50 that included a chronic illness benefit and a guaranteed premium refund option rider. The stated reasons for the purchase were to help pay-off their mortgage and debt, and to provide the survivor a pool of money to replace lost income during retirement accumulation period.
Fifteen years later, they decided to retire. Both were eligible to receive a company retirement plan and Social Security benefits. Jim was concerned that Sue may not have enough if he dies first. Sue was worried about the impact of a long-term illness.
Although the original reasons for acquiring the policies are no longer relevant, the policies can be used to address retirement fears. If Jim dies before Sue, she can use the death proceeds to help supplement her retirement income, and her policy can be used to provide a chronic illness benefit in the event of an illness that prevents her from performing two activities of daily living. Alternatively, if Sue dies before Jim, he has the option of maintaining his policy for its chronic illness benefits and family or charitable legacy, or surrendering the policy under the terms of the guaranteed refund option rider and seeing his premiums returned. That refund could be used to supplement Jim’s retirement income.
How DBS Can Help
It is common to think of term versus permanent as an either/or decision, when it may be appropriate to think in terms of both. To help you determine how much of each product your clients should consider, check out our Product Selector & Fact Finder on our website.
1It’s unknown when the phase was first used. Some credit it to A.L. Williams who established his company in 1977 based on buy term and invest the difference strategy. However, it’s clear that the phase predates this organization. In fact, Kiplinger’s Changing Times publication used it in a December 1961 article warning readers to be leery of mutual fund salesmen urging you to cash in whole life policies to purchase a combination term and mutual fund program.
2 See “The Proof That Most Investors Are Their Own Worst Enemy” Forbes June 13, 2016 by Brian Protnoy. Over the past 20 years, from 1996 through 2015, the S & P 500 returned 8.2%. Over the same time period, per DALBAR, the average dollar invested in mutual funds returned 4.7%.
3 See Wade Pfau, Optimizing Retirement Income by Combining Actuarial Science and Investments,” for a study in support of permanent life insurance and see Alan Roth “Is Buy Term and Invest the Difference on Life Support,” Financial Planning, December 4, 2015 for an article questioning the assumptions used in the study.
4 Michael Smith “The Insurance Policy as an Options Package,” Journal of Risk & Insurance 49, No. 4 (1982): 583-601.
