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Lower Your Volatility - Life Insurance Strategies

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Are Insurance Costs Increasing Your Volatility?

Each month, insurance costs are taken from your Universal Life policy. Often the contract will default to taking a proportionate amount from all investment accounts. However, if taken from the wrong account at the wrong time, you could be drastically increasing the volatility of your UL investments, and over time potentially significantly reducing your return.

Assume you invest $10,000 in a UL policy which earned 6% in one month and -5% the next. At the end of the two months you would have $10,070. Now let’s reverse the order and say the investment returned -5% the first month and gained 6% the second. You would still end up with $10,070.

Now let’s add insurance costs of $300 per month into the equation. If the costs are taken out at the beginning of each month, and the investments return 6% and -5% respectively, at the end of this scenario you would have $9,482.90. If we take the second scenario and reverse the returns while taking the charges out, you are left with only 9,449.90 – a difference of $33 over a two month period!

As you can see by the above example, the timing of returns has an impact on your UL investments when insurance costs are taken into account. Over a long time period, this effect can greatly increase the volatility of your UL portfolio. In periods where there are a lot of early negative returns, even a "fully funded" policy can lapse. Since there is no way to predict the returns of equity-linked investments, how do you protect yourself?

To protect yourself from this scenario, the best method is to allocate some of your investments to fixed-income accounts and have the costs deducted only from these accounts. This will not necessarily improve the performance of your investments, but over time it will greatly reduce the volatility.

If you wish to discuss this Universal Life strategy, or have any other questions about insurance, feel free to give us a call at 1-877-628-6762

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