Many value-oriented (and financially savvy) households stick to the adage of “buy term insurance and invest the difference”. The idea is that instead of buying the more expensive permanent insurance such as whole life, you can buy term insurance and invest the difference.
For example, a 30-year term life policy for a 33-year-old man may cost $939 in annual premiums, compare that to $11,290 for a whole-life policy. So instead of choosing the whole-life, he invests the $10,351 annual difference in a portfolio with a net after-tax return of 5.19%. In 30 years, the invested money grows to $746,997. However, if you still need coverage after the term-life expires, the annual premium might be something like $29,589.
Professionals disagree on which option is better. Some argue that “buy term insurance and invest the difference” does not work so well when the market craters, like last year; but I think that really depends on how you are investing that money. The way to think about it is what does the insurance company do with my money when I buy the whole-life? They go and invest it in conservative instruments to match their long-term liabilities, not in a 80% equity portfolio. We can do the same.
In fact, to make things simple, buy term (ladder them if expect expense needs to change over time) and invest the difference in a target date fund with the same date as when the term-life policy expires. Hopefully you will be smiling happily to know 10, 20, or 30 years from now that you’ve pocked the compounded difference instead of your friendly insurance company.
