Should You Buy Term and Invest the Difference?

Most people want to save for retirement and have the benefits of life insurance too. To help make this possible, insurers and entrepreneurs have developed life insurance plans and strategies to help people balance the need for life insurance and saving for later in life. One popular strategy that many people discuss is to buy term and invest the rest. In this article, we’ll discuss what this strategy entails and whether or not it’s a viable option to save for retirement and make the most of your life insurance. 

The Theory Behind Buying Term and Investing the Rest

Permanent life insurance essentially has two main benefits: a death benefit and the opportunity to acquire cash value. Because term insurance does not offer cash value, permanent life insurance premiums are higher than term insurance. 

Some people rationalize that they could still receive the two benefits of permanent life insurance by buying term life insurance (for the death benefit) and investing the rest of the money that they could have spent on a permanent life insurance plan (for the accruing wealth). To many it’s appealing to have the safety net of a life insurance policy and death benefit with the lowest premiums available while their invested money can then be used for immediate benefit or saved for retirement. 

This strategy was created by A.L. Williams in the 1970s. Williams’ strategy is based on the idea that most people need more coverage than they can afford to buy in a permanent life insurance policy alone while they’re young, but then as they get older, they don’t have as many liabilities or dependents, so they won’t need as much coverage anymore. Because of this change of financial position Williams recommended this strategy, to buy term life insurance but invest the difference in the stock market or real estate. When this strategy took off in the 1980s, the strategy looked good and worked well because the market performed well and returned well for those who used this strategy. 

To really understand the strategy, you need to understand the two assumptions the strategy relies on. The first assumption is that the market returns are better than the return you could get otherwise. This essentially means that for the strategy to hold up and perform, the market needs to return more money than you could get from accumulating cash value in a permanent life insurance policy. The second assumption is that you won’t need the death benefit when the coverage expires. This strategy relies on you allowing your term insurance to expire and using your invested returns for retirement, but it requires that you won’t need the death benefit at that point. These assumptions don’t always hold in reality though, however appealing they look in theory. 

The Challenges with Buying Term and Investing

This strategy may have looked good in the 1980s, but there are many challenges in reality that can make the theory fall apart. Here are some of the main challenges that come with the “buy term insurance and invest the difference” strategy. 

  • The market doesn’t always go up. The market has good and bad days, but it won’t always close high. This strategy is completely dependent on the market performing well, yet the market won’t always do well. Timing is absolutely crucial in market returns, but it’s impossible to determine how well the market will perform at a given time. This is the major challenge you’ll face with this strategy and the one with the largest consequences. 
  • Diversified portfolios have different rates of return. A good investment strategy will almost always include a diversified portfolio. Nobody wants to put all of their eggs in one basket. A good portfolio will include some safer investments to make up for the fact the market doesn’t always go up. But these safer investments have lower rates of return, and those lower return rates can mean you aren’t able to make as much money as you’d intended. 
  • Market performance won’t always equal your premiums. The only way to truly make money with this strategy is to make more money in the market than you pay for your term insurance policy. To make up for your term insurance premiums, you need a return rate in the market of about 6–9%. The challenge is your daily returns could be lower than this amount and could result in spending more on your insurance policy than you make in the long run. Especially if you run into a time when market returns are around 5%, you will struggle to actually make money with this strategy. 
  • Some people don’t actually invest the difference. Many people start out with all the intentions in the world to buy term and invest the difference, but when it comes to reality, it doesn’t always happen. Some people get caught up in the daily struggles and life and never get around to investing the difference or they wait too long to start. This dose of reality is a harsh testament to the fact that good intentions don’t translate into profits.

Strategizing with Whole Life Insurance Instead

Term insurance can be extremely beneficial for some people, especially young people. But this term insurance strategy has many challenges leading to one big problem: uncertainty. Nothing about buying term and investing the rest is guaranteed. The stock market could crash at any point, or you could end up spending more on your premiums in the long run. So instead of strategizing with this theory, you could strategize with whole life insurance instead. 

Whole life insurance has guarantees the entire time you have the plan. You are guaranteed a death benefit if you ever need one at any point without having to worry that your coverage may expire right when you need it most. You also don’t have to pick the right days in the market and rely on that for accumulating cash value. Whole life insurance provides a guarantee of accumulating cash and equity in the long run that you can then use for retirement or other things while you’re still alive. Your cash value isn’t dependent on the market returns. These guarantees can take time to grow, but they will develop because they aren’t dependent on anything else. And,  you’ll still get benefits along the way. 

Keep in mind that you can choose whole life insurance and still have an investment strategy. Buying a permanent life insurance policy doesn’t mean you can’t also create an investment portfolio and take advantage of the market when you can. The key is that saving and protection in your finances should come first before any risks. The strategy of buying term and investing the difference doesn’t provide protection or guaranteed savings the entire time. Whole life insurance can provide savings and financial protection while still leaving you the flexibility to invest. 

If you’re not sure what the best life insurance strategy is for you, our experts here at Life Benefits can help you figure it out. We can help you create the right life insurance policy and determine how you should be using that to have financial protection as well as savings for now and retirement.