8/14/2019 Modern Portfolio Theory, Asset Classes, and Life Insurance

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Modern Portfolio Theory, Asset Classes,

and Life Insurance

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Dont Put All Your Eggsinto One Basket

The simple idea behind Modern Portolio Theory (MPT) is

diversifcation o asset classes to achieve the best risk/return

ratio or your needs, liestyle, nancial situation, and personal

preerences. The rst step is to identiy asset classes. Most

advisors agree that the primary classes include:

Equities (common stocks)

Fixed Income (bonds and mortgages)

Money Market (cash)

Guaranteed (annuities)

Real Estate

The next step is to diversiy assets among and within these classes

in order to oset both systematic risk recession, interest

rates, and the like and unsystematic risk or risk specic to

individual stocks, businesses or industries.

No matter what precautions are taken, there is typically some

reduction o earnings rom all o the above asset classes due to:

Volatility

Infation

Taxes

Fees

For example, rom 1977 through 2006, total equity returns

o Large Cap stocks (comparable to the S&P 500TM

) refecteda nominal compound annual rate o return o 12.27%. With

the eects o taxes and investment ees (2.63%) plus the

compound infation rate (4.45%), the actual compounded rate

o return over the 30-year period was 5.19%.3

Timing is Everything

For those seeking less short-term risk and volatility,

Treasury Bonds had a 30-year compounded real rate o

return over the same period o within a range o 0% 2%,and Municipal Bonds produced a compound return o 1.8%.

The shockingly low reward was a trade-o or the higher

security o capital during that time. In a shorter time rame

rom 2001 12/31/2006, Large Cap stocks produced a real

return o just 2.02% while International Stocks were up

10.01%.4

Modern Portolio Theory isone o the most important and

relevant economic theories

developed in our lietime, and has

greatly infuenced the movers and

shakers in the investment world as

well as most individuals with some

discretionary income to save.

The idea o balancing return with

risk in a paradigm-shiting approach

toward an ecient rontier

was developed in 1982 by Harry

Markowitz. He shared a Nobel Prize

in 1990 with Merton Miller and

William Sharpe or what is now

the best-known and most widely

accepted method o portolio

selection.2

2

The Living Balance Sheet, a web-based tool that gives individuals and businesses the inormation

they need to v iew current fnancial situations and build efcient strategies or the uture.

Live for today and prepare for tomorrow

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Legacy Planning

Because the lie insurance death benet is paid in ull at the

event o death, no matter what the timing, the legacy value

o the bond/lie insurance combination delivers a signicantly

greater result in every year.

Legacy Value o Bond Plus Insurance Death Beneft

The synergy in unding a lie insurance policy rom the income

stream o a component o a xed portolio is this it will typically

produce a more avorable result because the return will be

higher and the risk lower achieving the ideal ecient rontier

highly sought in the applications o Modern Portolio Theory.

Lets Look at Another Example

This variation evaluates the 45-year-olds $500,000 municipal

bond/xed component in the ability to maximize retirement

distributions as well as the legacy value at lie expectancy:

Option 1: $500,000 Bond Investment Converted to

Income at Age 65

Accumulated value at age 65 $1,095,562

Interest-only ater-tax income

beginning at age 65 42,137

Portolio legacy value at

lie expectancy +5 1,095,562

Risk index 2.48

Net ater-tax return 4.0%

Option 2: Bond income to pay $20,000 annual

premium on a 20-Pay Whole Lie Insurance Policy;

$1,064,171 Face Amount; Amortize Income rom

Age 65 89

Bond accumulated value at age 65 $ 476,178

Policy cash value at age 65 611,711

Total cash value at age 65 $1,087,889

Interest/principal ater-tax income

beginning at age 65 49,308

Portolio legacy value at lie expectancy +5 0

Whole Lie insurance death benet $1,357,789

Risk index accumulation phase 2.10

Risk index distribution phase 2.43

Imputed net ater-tax return 4.52%

Take-Aways

1. Diversication is critical or a well thought-out portolio.

2. Risk prole and time horizon are both important

considerations in developing investment choices.

3. Permanent lie insurance is a qualied asset class, and

provides the ideal capstone to a solid, balanced nancial

strategy.

1This brochure is derived with permission rom Lie Insurance as an Asset Class:

A Value-added Component o an Asset Allocation, by Richard M. Weber, MBA,

CLU and Christopher Hause, FSA, MAAA, both o Ethical Edge Insurance

Solutions, LLC.

2Asset Allocation , Roger C. Gibson, McGraw Hill 2000. Third Edition.

3A Study o Real, Real Returns, Thornburg Investment Management, 2007.

4 Ibid.

5 Riders may incur additional costs.

6 Charts and examples derived rom Lie Insurance as an Asset Class:

A Value-Added Component o an Asset Allocation , by Richard M. Weber, MBA,

CLU and Christopher Hause, FSA, MAAA. Please note that deduction o all

applicable ees and charges could result in lower perormance than shown

in examples.

The Guardian Lie Insurance Company o America 7 Hanover Square New York, NY 10004-4025 www.GuardianLie.com

ub. 4082I (03/08)

Bond Value

Bond + Death Benefit

Age

45 50 55 60 65 70 75 80 85 90$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000