Financial Products

The Life Insurance Choice Dilemma

Too many choicesToday’s tumultuous economy and changing consumer attitudes make the life insurance purchase decision challenging. Both term (temporary) coverage and permanent coverage have their relative advantages and disadvantages. Here, in brief are the choices:

Term Life? This provides an affordable entry point, but  coverage is temporary. The cost of insurance increases over time as the insured’s life expectancy decreases, eventually making coverage less affordable.

Permanent Life?  Permanent policy options can be complex and confusing:

  • Whole Life provides protection to at least age 100, but tends to be more expensive, difficult to understand, and inflexible.
  • Variable Life allows for improved cash value potential, but exposes the buyer to market risk.
  • Universal Life is interest sensitive, and policies purchased during high interest rate periods  suffered adverse performance as rates declined.

What Consumers Want: Control, Clarity and Value


Given all these choices, how can consumers decide which product is best suited to their own needs, circumstances and priorities?

A recent study by LIMRA and LIFE Foundation  can help shed some light on consumer priorities. While individual circumstances will vary, the study shows that general consumer insurance buying patterns and  priorities have changed over the past 15 years.

The study’s  findings strongly suggest that life insurance shoppers, influenced largely by the internet, tend to seek these 3 things:

1. Control/Flexibility

  • 26% say they prefer to purchase life insurance by internet, mail or phone.
  • 64% still prefer to buy from an insurance or financial professional face to face (although this is down from 80% in 1996.)

2. Clarity/Simplicity

When asked what factors matter most to them in buying insurance, consumers cited:

  • #1: Understanding what they’re buying (36%.)
  • #2: Obtaining the proper coverage amount (22%.)

3. Affordability/Value

Although the cost of basic term life has fallen by about 50% over the past 10 years, consumers are still concerned about the price of coverage:

  • Cost is the top reason people give for not owning enough life insurance.
  • Men place value getting the best price more than women: 17% vs 11%.

And in the wake of the 2008 recession and the weak recovery, there is also increased sensitivity to risk and volatility, making the stability of guarantees more important.

How Guaranteed Universal Life Fits In

Responsive life insurance companies are addressing consumer demand for control, simplicity and value with a new generation of guaranteed Universal Life policies.  These new products are designed to meet consumers’ needs while overcoming the challenges that the older generation of Universal Life policies encountered. Here’s how:

1. Clarity/Simplicity: Universal Life (UL) is based on a comparatively simple and transparent design (as illustrated below). It provides a clever way to combining term life insurance with a saving plan:

  • a portion of your premium pays for the cost of insurance.
  • a portion is reserved as cash value that can be used in the future to reduce the cost of insurance and provide cash when you need it.


2. Control/Flexibility:

When times are hard, the cash accumulation fund provides a cushion that can allow you to skip premium payments, and when times are good, there is flexibility to increase your premium payments to enhance that savings element. You can decide how much of your premium dollars go to savings to generate more significant cash values that accrue tax deferred and can be used for contingencies such as:

  • Unpaid medical bills – Few people anticipate the need for additional money during a prolonged illness. Cash value in the policy can be withdrawn, or borrowed, to pay medical bills.
  • Higher education – College funds are built over a sustained period of disciplined saving. While funds are not accessible in the early years of the policy, cash values are available when children are ready for college.
  • Retirement supplement – Additional income during the retirement years can be helpful when other sources are not available.

It is possible to arrange to pay a premium for a certain number of years only – such as 10 or 15 years while still guaranteeing lifetime coverage. UL policies also allow for a choice among death benefit options: a Level Death Benefit, in which premiums and interest primarily increase the cash value, or Increasing Death Benefit, in which they are also used to increase the death benefit over time.

3. Affordability/Value: UL provides cost control and value in the following ways:

  • Affordability: While more expensive than term life insurance, UL is less expensive than whole life insurance.
  • Value: Guaranteed Universal Life (GUL) provides the value of guarantees, so that both the coverage and premium level will last to a certain age regardless of current interest or economic conditions. In response to increased life expectancy, some policies provide coverage up to age 121. Policies also provide a guaranteed minimum cash value.

Buying Life Insurance is About More than Price

Under the right circumstances, Universal Life Insurance can provide permanent coverage that stays in force as long as the premiums are paid or beyond. Proper management of the savings component enables the funds to grow tax deferred at a steady rate until the money is needed. Additional standard or optional benefit features provide additional value and flexibility, including:

  • Self Completion: an optional Waiver of Premium benefit will waive the premium payments in the event of disability, allowing the policy to stay in force.
  • Accelerated Death Benefit: This standard benefit enables the policy holder to receive cash advances against the death benefit if diagnosed with a terminal illness.
  • Partial Surrender Benefit: This standard feature lets you take a portion of your cash value out of the policy instead of surrendering the entire policy for the full value, lowering the death benefit by the amount you withdraw.

In today’s volatile economic environment, changing consumer attitudes and priorities have created a need for simple, transparent, affordable, flexible products that provide solid guarantees. Unlike the older Universal Life products that were sold when interest rates were high and lost value as rates declined, today’s Guaranteed Universal Life products have been designed to provide sound guarantees during a time of low interest crediting rates. And with interest rates at their current historic lows, there’s room for future growth over time.

For consumers who are seeking affordable, customizable permanent coverage, it may be time to take a fresh look at Universal Life.

Is There a Ready Market for Your Business?

small businesses for sale

According to The Complete Guide To Business Brokerage By Tom West, the number of small to mid-sized, privately owned businesses for sale in the United States is estimated to be approximately 1 million – or 20% of them at any given time. But only a small number of them get sold:

  • 1 in 5 small businesses sell
  • 1 in 4 small to mid size businesses sell
  • 1 in 3.5 mid-size companies sell
  • 1 in 3 large companies sell

Shut Happens

There may be no ready buyers for your business, and you may lose your most hard earned asset. Consider this example.

out of businessExample:
 You and your partner  are 50/50 partners.  Your partner dies, and his wife or child inherits his share of the business.

  • Do you have the right or the obligation to buy them out? 
  • If so, for how much and on what terms?  
  • Can you strike out on your own, or are you stuck with the baggage of the old one? 

What if you die instead of your partner?

  • Will your partner pay your family a fair price for your share of the business?
  • Will he just walk away and start up a new business on his own?

The 3 Problems of Business Continuation

1. No buyers offering a fair price
 – There may not be a ready market for your business in even the best of economic times, and unforseen events like death or sickness can force a fire sale. You may work hard all your life to build a business, but have nothing to leave your family.

owner's son2. Forced Partnership with a spouse or child – If you don’t have the cash to buy out your partner’s interest,  you may find yourself in business with a spouse or child who may actually be a drag on the profits and viability of your business.

3. Can you leave a family legacy? – If you die before your partner, what assurance do you have that your surviving partner will pay your family a fair price for your share of the business?

Robert W. Wood, who writes about taxes and litigation issues for Forbes, sums up why a  buy-sell agreement is so important for anyone who owns any kind of business:

Without it, a closely held or family business faces a world of financial and tax problems on an owner’s death, incapacitation, divorce, bankruptcy, sale or retirement…A buy-sell agreement can ward off infighting by family members, co-owners and spouses, keep the business afloat so its goodwill and customer base remain intact, and avoid liquidity problems that often arise on these major events.

Creating a Market for Your Business

Business-succession specialists and financial planners often recommend an insured buy-sell agreement to ensure that your family can receive a fair value for the business you worked so hard to build, and allow you to buy out your partner’s share and continue the business as a going concern. It does two things:

  1. It creates an immediate market for your business (your partner or a successor employee.)
  2. It  can create immediate funds for a fairly valued buyout through insurance.

The 5 Guarantees of A Properly Structured Agreement


A properly-structured agreement will guarantee the following:

  1. guaranteed purchaser
  2. guaranteed sale
  3. guaranteed price
  4. guaranteed time
  5. guaranteed funding

1. Guaranteed Purchaser

Who will buy?

  • the surviving partners must buy

2. Guaranteed Sale

Who will sell?

  • the estate of the deceased partner must sell

3. Guaranteed Price

What is the price?

  • have a formula or outside valuation

4. Guaranteed Time

When to transact?

  • automatically at time of
    • disability
    • retirement
    • death

5. Guaranteed Funding

How to pay?

Implementing A Simple and Cost Effective Solution

Cross Purchase vs. Redemption:  One type of agreement is a cross-purchase:  If you or your partner/successor dies, becomes disabled, goes bankrupt, etc., the other can buy his share.  With a redemption style agreement, the business itself would make the purchase so the owners don’t individually go out of pocket.

With either type of buy-sell, there’s lots of flexibility.  The price might be fixed, determined by appraisal or formula.  The price might be paid in cash or installments over time.  There can be different terms for different events, one price and terms for retirement, one for disability, one for death.

Insurance:  Insurance features prominently in many buy-sell agreements.  You don’t have to use insurance, but it can ensure there’s cash available when the time comes.  For example, whether you or your partner/successor dies first, a life insurance policy on each of you can fund the buyout so your business stays afloat and the spouse/heirs are bought out as agreed.  A buy-sell agreement is funded with life insurance on the participating owners’ lives can guarantee that there will be money when the buy–sell event is triggered. Using insurance to fund the buy/sell agreement has these advantages

  • funds are available when needed
  • least expensive solution
  • new owner does not incur debt when buying the business

Reciprocal Planning:  While you may find it difficult to face these issues and to make some of the decisions, any buy-sell agreement is better than none.  The best thing about buy-sell agreements are that they are reciprocal.  No one knows for sure if you or your partner will be the first to go by death, disability, retirement, or for other reasons, and this reciprocal nature makes negotiating and agreeing on these issues easier to do.

How to Get Started

You’ll need a business or tax lawyer experienced in buy-sell agreements to draft it.  However, these agreements can be surprisingly simple and cost effective. Whatever you pay for it and the insurance premiums on an insured arrangement will be small in comparison to what it can save you. 

One of the best starting points is a financial planner or insurance specialist. They may have prototype documents to recommend to your attorney, but, more important, they may have invaluable experience and can give you guidance in thinking out the key decisions before you meet with an attorney to get it done, which will save you time and money.

Additional Resources:


Gold Didn’t Pan Out

gold tumbles

April 2013: Gold dropped to its lowest level in two years – on top of a 10% fall over the past six months.

Gold was supposed to be a secure investment in an uncertain time – so much so that an April 2011 Gallup poll found that 34% of Americans thought that gold was the best long-term investment, more than another other investment category.

Then,  two years after its price reached a new high, it plunged to its lowest level in over two years, falling 19% since late 2011. This is the greatest decline in 33 years, amid record-high trading.

According to the New York Times, the crash of a golden decade of rising prices caught many investors by surprise. Morningstar reports that $5 billion  had flowed into gold-focused mutual funds between 2009 and 2010, bringing those funds to a peak value of $26.3 billion in April 2011. These funds lost half of their value:

It is a remarkable turnabout for an investment that many have long regarded as one of the safest of all. The decline has been so swift that some Wall Street analysts are declaring the end of a golden age of gold. The stakes are high: the last time the metal went through a patch like this, in the 1980s, its price took 30 years to recover.

In a time of plunging global interest rates, why did investors flock to a traditional  inflation hedge?  Why were they willing to buy at such high prices? It seems that many investors mistook gold for a product that could provide them significant protection against economic risk – more in line with an insurance product.

What’s A Safe Investment?

It’s certainly understandable that people would seek a safe haven at a time when many are losing faith in their political and economic systems. However,  given that there are few safe investments to turn to considering the low returns that interest-bearing products have been offering, the allure of gold was perhaps understandable:


Investopedia’s “4 Safest Investments Right Now” – which includes TIPS, I-Bonds, Short Term Bond Funds, and Bank CDs –  have such modest returns that they essentially just aim to preserve principal. Investopedia states:

Any one of these options represents a low-risk low-return solution to preserving principal. You won’t earn much in returns with these securities though. In most cases it will be just enough to keep level with inflation. If you need capital appreciation over the long term, you’ll have to take on more risk.

A Different Approach to Wealth Preservation

One financial vehicle that has recently been enjoying a resurgence of interest is permanent life insurance.  life-insurance-age-range

2012 was a very big year for permanent life insurance sales according to research and consulting firm LIMRA, :

  • Total individual life insurance new annualized premium grew 6% — the third straight year of growth.
  • Total individual life premium grew 12% in the fourth quarter — the largest growth recorded since the downturn.
  • Life insurance policies sold grew 1%  — the second consecutive year of positive annual policy growth.

The fourth quarter of 2012 was the biggest quarter for life insurance sales in a very long time – in fact, there hasn’t been a quarter in which all of the major product lines experienced growth since 2006. And the last time individual life insurance policy count increased two years in a row was back in 1980-1981.

Creating Certainty In An Uncertain World

Why the sudden resurgence of interest in life insurance? LIMRA’s Product Research senior analyst Ashley Durham attributes growth to a few different factors, including a continued attraction to guarantees and growth potential. What differentiates permanent life insurance from other financial vehicles are 3 unique benefit features:

1. Competitive Return Potential

high returnIn today’s volatile markets, secure financial vehicles that provide competitive returns are hard to find.  In an environment of such low returns, permanent life insurance’s cash value provides an interesting alternative.    and  put it this way in Advisor One:

Considering the premium placed on stability in recent years, investing in a permanent life policy might be the best bargain on the market.

2. Lifetime Guarantee

In addition to providing a cash value savings element, permanent life insurance provides a feature that other financial vehicles doLifetime-Guarantee not: lifetime guarantees.

Given increased life expectancy and declining health over time, there is no guarantee that the money you put aside for your beneficiaries will ever reach them. You are likely to need it first for medical or other expenses. However, if you own permanent life insurance, you can access policy cash values without surrendering the death benefit. There is also little chance of outliving a permanent life insurance policy, because permanent life policies can remain in force to age 100, and with some policies, to age 120. And, although you may be living on a fixed income as a retiree, life insurance premiums remain fixed for life, or can be paid up in advance.

3. Potential for Explosive Growth

A Wealth Multiplier: The transfer of risk is essential to life insurance. The risk of  a payout to you at death isn’t retained by you alone, but  spread out among all policyholders that the insurer does business with. All customers contribute money to the general account, which is invested, and then claims are paid from it when an individual dies. As a result, the  annual or monthly premium you pay is a small fraction of the benefit that will be paid to your beneficiaries at death.


Example: The chart shows a 65-year-old man who purchases of a policy with a $1,000,000 death benefit for a $26,000 annual premium. In the year of his life expectancy the adjusted Internal Rate of Return (IRR) of his death benefit is 5.88%, or, since he is not taxed, 8.17%.
If he passes away earlier, his IRR will be higher – as high as 108.28% at age 79.  
  • In other words, you don’t have to be a big saver to leave a substantial legacy to your beneficiaries. The death benefit paid to your beneficiaries can be many times what you paid into it.
Tax Efficient Transfer: The policy proceeds bypass the often lengthy and costly probate process, and are released to your beneficiaries immediately – which is when they are likely to need it the most – without taxation.

Short on Glitter – Long on Performance


This resurgence of interest in life insurance is a reminder of the uncertainty of our times, and an indicator of changing consumer attitudes. Consumers are more knowledgeable, and LIMRA research indicates that more knowledgeable people are on the subject, the more likely they are to own life insurance. LIMRA found that:

Respondents who knew the most about life insurance. citing multiple sources of information attributing to their understanding of life insurance, either owned life insurance themselves or had heard about it through work, a seminar or financial planner. Most were older, more educated and viewed life insurance as important.

It seems that the smart money is leapfrogging gold.  Life insurance may lack the psychological appeal and rich associations of gold – no pirate ship ever went down with universal life insurance contracts in their hold – but what it lacks in luster, it makes up for in substance and performance:

  • Many gold investors bought high and sold low. However, life insurance is actuarially designed to be bought low and sold high – the premiums represent just a fraction of the proceeds.
  • While the price and value of gold fluctuate subject to general economic conditions and investor sentiment, permanent life insurance usually offers a guaranteed level premium and a guaranteed death benefit.
  • For your beneficiaries, life insurance represents “inevitable gain” tax free.

A dull, plodding performer, life insurance nonetheless provides dependable benefits – it provides down payments to help young families buy their first homes, college educations to launch bright careers, hard cash to pay bills when the earner is not there to provide.

Gold certainly may have a place in your portfolio. Financial planners typically recommend that you allocate a small portion of your portfolio to it to serve as a hedge against financial risk. However, consider how much more protection investors would have by placing a portion of that into permanent life insurance.

Benefits Are More Costly – But More Important


Employers are struggling with employee benefit decisions.

In addition to the challenging economic  and competitive environment, employers now face three key difficulties


  • healthcare reform, 
  • precipitously rising benefit costs,  and 
  • a less loyal workforce.  

The conundrum employers face is that employee loyalty has been steadily declining, while employees are demanding benefits more.  The ninth annual MetLife Study of Employee Benefits Trends, respectively, showed that employees reported:

  • a 12% decline in “strong loyalty” to employers from 2008 to 2011.

Voluntary Life Benefit Programs Help Bridge the Gap

There is renewed interest among employers in voluntary benefits as a means of  promoting loyalty and retention while curtailing benefit costs. And the eleventh annual MetLife Study of Employee Benefits Trends reports that employees are keenly interested in them as well:

  • 61 say benefits meeting their individual needs would make them more loyal.
  • 51are willing to bear more of the cost to have more benefits to choose from.

Voluntary life insurance benefits are highly valued.  A special advantages of life insurance benefit programs is the flexibility that they provide employers in structuring a plan to meet their needs:

  • Avoids complicated reporting and nondiscrimination requirements, giving employers control over whom to reward. 
  • Costs and benefits can be split among employer and employees to fit the needs of the business. 
  • Employers can control the incentives by designing their plan with or without “strings.” 

Here are 3 popular ways that employer-sponsored life insurance benefits are  offered to select key employees

1. Split-dollar – for Cost and Benefit Sharing

RestrictedAccessBenefits: The costs and benefits of a policy are shared between the employer and a select key employee.

During employment: The employer and a select key employee each pay an agreed percentage of the premium.  This could be called a “consumer-directed plan” because it allows the employer to provide an executive with a life insurance benefit with low outlay.

At death: A tax-free death benefit is paid to the employee’s beneficiary,  and a portion goes to the employer to recoup it’s contributions.

At separation from service:  the policy’s cash value may reimburse the employer for his share of the premiums and allow the employee to purchase and keep the policy.

According to National Underwriter, this  continues to be a vital and popular planning tool.

Anticipated Results: Costs and benefits can be split according to the employer’s needs. The “rollout” of the benefit to the employee upon separation of service can be used to tie the employee to the company for a long period, encouraging loyalty and retention.

2. Deferred Compensation – for Executive Retirement

quote_executivesBenefits: Non-qualified Deferred Compensation plans can create tax-leveraged financial security for key employees by allowing them to defer a portion of their income into a cash value life insurance policy. The plan can provide benefits in lieu of or as a supplement to a qualified pension plan.The employee elects to receive less current compensation and defers receipt of that amount to a future tax year.

  • The cash value can provide supplementary retirement benefits, even if the employee is already receiving the maximum benefits under the company’s qualified plan.
  • The employer gets a tax deduction when the employee receives the compensation.  
  • The employer can avoid the cost and administration of a qualified plan and the cost and complexity of covering all employees.
  • The death benefit can allow the business to recover costs.

Anticipated Results: The deferrals provide a way for employees to save for retirement. The employer can select who receives benefits, when they receive them and how much they receive, and there are fewer administrative issues than under unlike tax qualified plans –  since the Department of Labor has ruled (Advisory Opinion Letter 90-14A) that this arrangement is not subject to Labor Regulations Section 2510.3-102, which requires participant contributions to an ERISA pension or welfare plan to be held under a formal trust arrangement.

3. Executive Bonus – for Trusted Key Employees

exe_bonusBenefits: The employer provides additional monthly compensation to the employee, and receives an annual tax deduction.

The bonus pays for the premiums of a life insurance policy owned by the key executive – a valued personal asset  giving the employee access to the cash values and providing a death benefit for his/her beneficiaries.

Anticipated Results: A Section 162 Executive Bonus Plan is one of the simplest and most transparent plans. For a more personal organization, it provides transparency and trust. It’s tax deductible to the employer, and provides a fully paid, fully vested life insurance benefit for a particularly important and trusted key employee.

A Good Broker/Benefit Specialist Is Key

Given the flexibility of these plans, it is important to have a qualified benefits specialist or broker, knowledgeable in life insurance planning to:

  • help the employer select the implementation strategy that fits its specific needs and objectives.
  • provide a prototype agreement for plans that require one.
  • promote participation and appreciation for the employer’s sponsorship.

Research indicates  that 68% of employees spent little time or effort in making their benefit selections; however,  employers who provide outstanding communications are more highly effective in enrollment and are more likely to report that their employees are highly satisfied with their benefits (82% vs. 61%.)

Voluntary Life Insurance Benefits can help give employers an edge in retaining valued, qualified key employees –  who are often the engines of growth for a business or practice. Retaining superior key employees also means retaining a superior benefits broker who can help with the planning, the implementation and the communication.

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The above chart is from  the ETF Database, a great resource for everything on ETFs.

Exchange Traded Funds In A Nutshell

Exchange-traded funds (ETFs) and mutual funds are both viable choices for investors. But, with all their similarities, what differences between the two should investors consider when deciding which to use?

General Overview

Launched in 1993, ETFs are designed to offer the diversification of a mutual fund and the liquidity and transparency of a stock. Whereas mutual funds can typically be traded only once a day, based on their end-of-day value, ETFs can be bought and sold in real time throughout the trading day. The ETF is similar to a mutual fund in that it is a diversified basket of investments. Like mutual funds, ETFs have a particular investment focus –  for instance, ETFs may be made up of only technology stocks, or energy stocks. They may follow indexes: there are some that follow the movement of the Chinese economy and others that track a basket of commodities like corn and wheat. But there are differences:

  • While a mutual fund can only be bought at the end of the day value, ETFs are traded on an exchange throughout the day just like a stock.
  • ETFs have managers but are not managed as actively as some mutual funds. Most of the underlying stocks stay the same over time which helps keep the fees much lower than most mutual funds.

Legal Structure

Mutual funds can typically be broken down into two types:

  • Open-Ended Funds
    Purchases and sales of fund shares take place directly between investors and the fund company. Federal regulations require a daily valuation process, called marking to market, which subsequently adjusts the fund’s per-share price to reflect changes in portfolio (asset) value. The value of the individual’s shares is not affected by the number of shares outstanding.
  • Closed-End Funds
    These funds issue only a specific number of shares and do not issue new shares as investor demand grows. Prices are not determined by the net asset value (NAV) of the fund, but are driven by investor demand. Purchases of shares are often made at a premium or discount to NAV.
An ETF will have one of three structures:

  • Exchange-Traded Open-End Index Mutual Fund
    Under the SEC’s Investment Company Act of 1940, dividends are reinvested on the day of receipt and paid to shareholders in cash every quarter. Securities lending is allowed and derivatives may be used in the fund.
  • Exchange-Traded Unit Investment Trust (UIT)
    Exchange-traded UITs must attempt to fully replicate their specific indexes, limit investments in a single issue to 25% or less, and set additional weighting limits for diversified and non-diversified funds. UITs do not automatically reinvest dividends, but pay cash dividends quarterly.
  • Exchange-Traded Grantor Trust
    This bears a strong resemblance to a closed-ended fund but, unlike ETFs and closed-end mutual funds, an investor owns the underlying shares in the companies that the ETF is invested in, including the voting rights. The composition of the fund does not change; dividends are not reinvested but instead are paid directly to shareholders. Investors must trade in 100-share lots. Holding company depository receipts (HOLDRs) are one example of this type of ETF.

Active Trading
ETFs offer greater flexibility than mutual funds when it comes to trading. For mutual funds, the price of the fund is not determined until end of business day, when net asset value (NAV) is determined. With ETFs, however, shares trade throughout the day between investors like a stock. Because ETFs are priced continuously by the market, there is the potential for trading to take place at a price other than the true NAV, which may introduce the opportunity for arbitrage. (See Arbitrage Squeezes Profit From Market Inefficiency.)

Lower Expenses
Due to the passive nature of indexed strategies, the internal expenses of most ETFs are considerably lower than those of many mutual funds. Of the more than 900 available ETFs listed on Morningstar in 2010, those with the lowest expense ratios charged about .10%, while those with the highest expenses ran about 1.25%. By comparison, the lowest fund fees range from .01% to more than 10% per year for other funds.Another expense that should be considered is the product acquisition costs, if any. Mutual funds can often be purchased at NAV, or stripped of any loads, but many have commissions and loads associated with them, some of which run as high as 8.5%. ETF purchases are free of broker loads. (See The Lowdown On No-Load Mutual Funds.)

In both cases, additional transaction fees are usually assessed, depending on the size of your account, the size of the purchase and the pricing schedule of the brokerage firm. If you plan to use dollar-cost averaging to buy into the funds or ETFs,  frequent trading could significantly increase commissions, offsetting the benefits resulting from lower fees.

Tax Advantages
ETFs offer tax advantages to investors:

  • As passively managed portfolios, ETFs (and index funds) tend to realize fewer capital gains than actively managed mutual funds.
  • ETFs are more tax efficient than mutual funds because of the way they are created and redeemed. For example, if an investor redeems $50,000 from a mutual fund, the fund must sell $50,000 worth of stock. If appreciated stocks are sold to free up the cash for the investor, the fund captures that capital gain, which is distributed to shareholders before year-end. Shareholders must pay taxes for the turnover within the fund.  But if an ETF shareholder wishes to redeem $50,000, the ETF doesn’t sell any stock in the portfolio, but offers shareholders “in-kind redemptions”, which limit the possibility of paying capital gains.
Potential for Less Liquidity
Broad-based index ETFs with significant assets and trading volume have liquidity. For narrow ETF categories, or even country-specific products that have relatively small amounts of assets and are thinly traded, ETF liquidity could dry up in severe market conditions, so you may wish to steer clear of ETFs that track thinly traded markets or have very few underlying securities or small market caps in the respective index.ETF Safety Concerns
Investors should not invest in ETFs of a company that is likely to disappear,  forcing an unplanned liquidation of the funds that could create a taxable event. Since it is impossible to gauge the financial viability of a startup ETF company, as many are privately held, you should limit your ETF investments to firmly established providers or market dominators.

The “Flash Crash”

The “flash crash” showed that ETFs can be far more complex—and risky—than their mutual-fund cousins. Worse, ETF investors were burned at the very moment they craved safety most. On May 6, when the Dow Jones Industrial Average fell as much as 9.2% during the trading session, many ETFs momentarily lost almost all their value, dropping to pennies per share. Exchanges decided to cancel any trades executed at prices 60% or more away from precrash levels, and ETFs, which account for just one-tenth of all exchange-traded securities, represented about 70% of those with canceled trades. Instead of behaving like broadly diversified baskets of stocks, ETFs performed like single stocks reacting to the actions of panicked traders. The market prices of the ETFs plunged 60% or more.

Making matters worse, many ETF investors had placed “stop-loss orders”  designed to protect investors by triggering a sale once the ETF hits a certain level. When ETF prices plunged, however, there were few buyers, and many sold far below the trigger price selected. Then the funds rebounded sharply, adding insult to the injury.

Mike Goldberg, 64 years old, of Sarasota, Fla., had purchased the PowerShares Dynamic Leisure & Entertainment ETF at about $15 a share and set a stop-loss order to be triggered at roughly $14. But when he checked his account after the flash crash, he discovered that he had sold some of the shares at just 13 cents. “I remember reading it and saying, ‘Was there a typo?,'” says Mr. Goldberg, who owns a travel-marketing company. “I was a little bit annoyed.” Ultimately, the trade was canceled.

That isn’t to say the flash crash destroyed the rationale for using ETFs. The funds often charge lower fees than traditional mutual funds, and offer easy access to broad slices of the market. And ETFs may allow investors who can’t afford a mutual fund’s minimum initial investment—often $3,000 or more—to buy a similar holding for the cost of a trading commission. Major firms like Vanguard Group and Fidelity Investments have even started offering commission-free trades on some ETFs.

With ETFs, “you can get lower fees and tax efficiency, so long as you tread carefully and trade wisely,” says Paul Justice, ETF strategist at Morningstar.

For those investors still willing to consider exchange-traded funds, here are some new rules to trade by.

Rule 1: Check your wonk tolerance.

The mechanics of ETFs are more complicated than most investors and financial advisers ever realized. If you aren’t willing or able to keep up with the swings in the market or the technical discussion that follows here, it is a good sign that you should stick to ordinary mutual funds.

Rule 2: Try not to trade on a volatile day.

Big institutional players can help ETFs trade smoothly and closely track their benchmarks. But when the markets dive, they won’t necessarily prevent ETFs from plummeting.

So-called market makers—firms that typically help maintain orderly trading in ETFs—need accurate values for underlying fund holdings to arrive at prices where they are willing to buy or sell ETF shares. As stocks swung wildly on May 6, it became tough for these and other institutional players to price ETFs confidently, so many stepped back from the market, potentially exacerbating the rout.

On the all-electronic NYSE Arca, the primary exchange for most ETFs, the lead market makers have certain obligations to keep ETFs trading smoothly, though the exchange doesn’t disclose all of its requirements. These firms made a “reasonable effort” to keep up with the fast-moving market during the flash crash, says Lisa Dallmer, a chief operating officer at NYSE Euronext who oversees exchange-traded products. But given the steep market decline, she says, “it clearly wasn’t enough, because we had trades going off at a penny.”

Many ETF trades on May 6 were executed at “stub quote” prices. These quotes are market makers’ placeholders, often bids to buy shares for just pennies, and never meant to be executed. The phenomenon bewildered even some industry veterans.

“I never heard of stub quotes before in my life,” says Jim Ross, senior managing director at ETF provider State Street Corp. STT +2.44%


Other institutional players, such as high-frequency firms that trade ETFs at blinding speed, also provide liquidity in normal markets. But in a meltdown like May 6, “you can’t mandate that a high-frequency trader stand up on the firing line,” says Gus Sauter, chief investment officer at Vanguard Group.

In the wake of the flash crash, exchanges and regulators proposed “circuit breakers” for individual stocks in the Standard & Poor’s 500-stock index, to help prevent another flash crash. The NYSE’s Ms. Dallmer says the exchange has proposed a list of ETFs that could be a part of this circuit-breaker pilot program, pending the Securities and Exchange Commission’s approval.

Even so, small investors are better off not trading ETFs on the market’s wildest days. And for investors who aren’t comfortable with all of these arcane exchange policies, there is a simpler solution: Stick with ordinary mutual funds.

Rule 3: Use the right kind of trade order.

Even the procedure for buying or selling an ETF can trip up investors.

A “market order” means the trade will be executed at whatever price the market gives you. But as the flash crash showed, those market prices can get unpredictable—quickly.

Investors trading ETFs should use “limit” orders, says Morningstar’s Mr. Justice. That means the trade will be executed only within a specified price range. “You’re not guaranteed execution, but at least [you’re] guaranteed a price,” Mr. Justice says.

Among the strangest results of the flash crash are stop-loss orders turned upside-down.

Dave Hamra, a financial planner who runs Gordian Advisors in Tucson, Ariz., had bought shares in the Vanguard Total Stock Market VTI +2.06% ETF for two clients at about $54 apiece. He placed a stop loss at $50. On the afternoon of May 6, as the ETF’s price bungee-jumped around, Mr. Hamra’s clients got stopped out at an average price of $57.40, or 15% above the stop-loss he had set.

“It was really, really weird,” Mr. Hamra says. Though he has found no explanation for what happened, “I’m much less inclined now to use any stop losses at all,” he says.

Rule 4: Pay attention to trading costs.

Investors tend to think of ETF trading costs only in terms of the commission paid to buy or sell. But the “bid-ask spread,” which is the gap between the price buyers are willing to pay for ETF shares and the price sellers are asking, also can take a sizable bite out of returns.

Though ETFs appear highly liquid, trading billions of shares per day, that liquidity is largely concentrated in a handful of funds. At the end of April, the 10 ETFs with the largest dollar trading volume accounted for more than 60% of total ETF volume, according to the National Stock Exchange.

During the flash crash, typically narrow bid-ask spreads on some ETFs widened considerably. The iShares Russell 3000 Value Index, for example, had an average bid-ask spread of four cents in the first four months of this year; on May 6, its average spread was $2.29, according to NYSE Arca. Investors should generally be wary of ETFs with bid-ask spreads of more than five to 10 cents, analysts say.

Rule 5: Check the underlying value of the fund holdings before trading.

ETF market prices typically hew closely to the value of the fund’s underlying holdings. That is partly because big investors known as “authorized participants” can swap ETF shares for baskets of the underlying securities, arbitraging away any valuation gaps between the two.

But during the flash crash, some ETF prices momentarily bore little resemblance to their underlying holdings. The Vanguard Total Stock Market ETF, for example, seemed to track the market through its sharp decline and the start of its recovery, then collapsed again as its price briefly hit 15 cents, according to a regulatory report.

ETFs also can trade at prices substantially above their net asset value.

To determine if an ETF’s market price is reasonable, investors should check its “indicative” net asset value before they trade. The INAV, calculated every 15 seconds, is an up-to-date snapshot of the value of the fund’s holdings.

The flash crash showed that ETFs require lots of legwork, prompting some investors to wonder if the securities are worth the hassle. Mike Personick, a 33-year-old Salt Lake City small-business owner, is trying to switch from ETF market orders to limit orders in light of the crash. But if it is too much trouble, “I’ll go back to mutual funds,” he says. “I don’t have time to sit around and watch the market all day.”

Investopedia has a tutorial that you may find useful:

Needed: Versatility for Multiple Life Stages

Research Findings:

A survey conducted online by Harris Interactive on behalf of Northwestern Mutual from August 10-14, 2012 among 2,097 American adults ages 18 and older, featured in Insurance Newsnet finds that the motivation behind life insurance purchase and ownership differs considerably by age and lifestyle. Key findings:

  • Younger Insureds (18 – 34) are most likely to have purchased life insurance due to the birth of a child (28%)
  • 55+Insureds: 36% were prompted to buy as a result of marriage; 31% as part of a retirement plan
  • 45 – 54 Year Old Insureds – were prompted by marriage (39%) ; Retirement planning (25%) and homeownership (25%).
    • This group had the highest percentage (69%) of those who said they feel secure as a result of owning life insurance

Implications: Life Insurance Serves Different Functions by Consumer Life Stages

David Simbro, senior vice president at Northwestern Mutual believes this illustrates the great versatility of life insurance products: Life Insurance Serves different functions by life stage:

It is important to have a financial plan that can both support you and evolve across the span of your lifetime as your financial situation changes. Life insurance can be a stable and yet flexible cornerstone of a financial plan – protection if you need it while also helping you meet financial goals at various life stages.

When asked what aspects of life insurance provide peace of mind, responses differed by generation:

  • Debt Settlement- 18 – 34:  35% are significantly more likely than those ages 35-54 to have peace of mind as a result of knowing all their debts are paid
  • Family Protection- 35 – 44 (34%) and 45 – 54 (36%): derive the greatest peace of mind knowing that their family will be provided for in the event of their unexpected death.
  • Retirement- 55+: 31% find the most peace of mind in knowing that they will have enough money to live in retirement

Takeaways: In summary,

  • Young people focus on building wealth and paying down debt,
  • Those heading into retirement are concerned with managing their longevity risk.

This range of concerns shows why it is critical that a long-term financial plan have built-in flexibility. Life Insurance can fit at every stage, and is necessary at every stage. Unfortunately, many people do not recognize the need for or the flexibility of life insurance as an important part of their financial portfolios.

 Life Insurance Flexibility Not Well Understood

The Harris/Northwestern poll also indicates that people are not always fully leveraging the financial security of life insurance. Few noninsureds understood the role of life insurance in providing for:

  • Education (15 percent)
  • Childcare expenses (11 percent)
  • 33% weren’t certain what expenses they would need to cover at all.

Even among insureds, many still overlook potential uses of life insurance:

  • 52% say they were motivated to purchase it in order to provide for loved ones.
  • Only 6% were motivated to purchase a life insurance policy to fund an inheritance for heirs or charities/non-profit organizations.

Simbro points to an important marketing challenge – to educate the public about the flexibility inherent in life insurance:

A lot of people assume that life insurance is a basic inflexible product, but the fact is that our life products aren’t just flexible, they’re double-jointed – they have both living and death benefits that can be an appropriate foundation for many individuals.

An Approach to Planning for Flexibility

To provide yourself a benefit that will provide an adequate level of benefit to cover your debts and the needs of your beneficiaries, while allowing you the flexibility to plan for cash needs that arise, you should allocate a certain monthly amount of your financial portfolio toward two components:
  • Life insurance component.
  • Savings component.
Finding the perfect mix means that you need to determine how much to allocate to take care of both life insurance and savings elements of your longer term planning needs.
  • A cash value life insurance held for a longer period can provide you funds for unexpected financial needs.
  • A term insurance policy can allow you to maximize the amount you put into a separate savings vehicle, provided you plan for the eventual premium increase.

Is There a Perfect Product Solution?

Don’t Settle For A Stock Answer: I recently attended a seminar in which a local financial planner was asked why it was important to have an attorney draft your will when there are now lower cost online resources for this. His answer:

Sure, you can get a will online. You can also do your own dental work.

The Right Answer: Offering a simplistic stock answer for such a complex a question hurt his credibility.  The planner had likely picked up this answer at a sales seminar in which he had been coached to overcome objections rather than to actually listen, analyze, and provide a thoughtful analysis based on a client’s unique life needs.  A more accurate answer would have been:

It depends on the complexity of your situation. For clear and simple family planning circumstances, a basic will should suffice. The more complex your estate and personal circumstances, the more you may benefit from professional advice.

Is There a Right Life Insurance Policy?

This anecdote illustrates that there are various approaches to planning that can involve diferent product solutions. While life insurance products provide great flexibility, planning can be challenging. As Simbro states:

There are many factors that impact what type and how much insurance you need, and getting it right for your personal situation is best accomplished via a thoughtful planning process with the help of a trusted financial professional.

Permanent cash-value policies provide guaranteed level premiums, varying degrees of flexibility in premium payments, cash values you can access during life, and tax deferred growth. They include:

  • Whole life.
  • Universal life.
  • Equity indexed life.

Term life alternatives that provide temporary coverage at lower premiums include

  • Annually increasing premium Term life.
  • Level Premium term life.
  • Term life that provides a return of cash value.

Finding the right product solutions to fit your unique circumstances means taking into consideration the following factors:

  • Your needs at your current stage of life.
  • Your changing future needs.
  • Your ability to pay a sufficient premium level to provide for both.


  • The most important takeaway is that you can’t afford to neglect your life insurance needs. As your situation in life changes, so do your needs, and you need to keep up with them.
  • Analyze your current and future needs to ensure you are providing yourself:
    • Adequate coverage,
    • Flexibility for future and unforeseen changes, and
    • Affordable premium payments.
  • “You get what you pay for” – Too low a premium may compromise your plan: it can cause your policy (term or permanent) to require increased premiums later that you might not be able to afford; or it could compromise your planning flexibility over time.
  • Research resources online to help with your planning, such as these from Northwestern:
Snap! principle of life insurance premiums:
While you shouldn’t overspend, remember this principle: skimping on life insurance premium is only cheating yourself.

Marketing Returns

Jim Lowell, Fidelity Investor, in a Forbes article, brings our attention to two possibly misleading practices in reporting performance numbers that can be used in Mutual Fund advertising campaigns:

  1. How fund returns are calculated.
  2. Who earned those returns.

1. Annualized Returns Don’t Tell the Whole Story

“Annualized” returns don’t tell the whole story on fund performance. In fact, they can mask the real story.

Flat Yet Soaring?Jim gives the example of 2005, a volatile year, and by the third quarter, returns were flat. Yet, looking at the chart below, several funds report being up. How can that be?

In times of high volatility, the performance numbers you see over a period of a few months can be very confusing when taken out of context. This can make the quarter-end rankings of mutual funds by their three-year, and sometimes five-year, numbers unreliable. Citing returns through the end of 2005’s third quarter focus on single-period returns, and lack context. Returns for the single 3-year period and single 5-year period ending in September 2005, can be very misleading.

The Greater Context – Compared to What?: The bear market virtually hit bottom at the end of September 2002, hitting a nadir in mid-October before rebounding for a positive return that month. Consequently, by the end of the third quarter, 2005, the 3-year returns ending September 2005 would be up compared to that dismal period, and that would make them look a bit too rosy.

By contrast, the 5-year numbers might look a little worse than they should, given that their starting point, the end of September 2000, saw the stock market just 6% below its March record high.

The table below shows (in red) spectacular looking annualized 3 year returns, while the five-year numbers mostly look dismal. The net result is that, ranking the funds by their 3-year returns, the ranking would look quite a bit different from the ranking based on 5-year returns.

However, look at the average 3-year and 5-year rolling returns for each of the funds in the list based on monthly performance going back 10 years (in blue.) Ranking the funds by these rolling return figures, youfind much greater consistency in relative fund performance.

One important reason is that the 3- and 5-year returns measure just two time periods, but the rolling returns measure more than 80 three-year and more than 50 five-year periods.

Annualized Returns Are Inconsistent, Rolling Returns More Consistent

Fidelity Fund 3-Year  Annualized % Return 5-year Annualized % Return 3-Year Rolling % Returns 5-Year Rolling % Returns
Aggressive Growth 17.1 -20.7 3.3 -2.4
Capital Appreciation 20.1 0.3 8.4 6.5
Contrafund 15.8 3 9.6 7.5
Value 20.4 14.4 9.2 9.1
Utilities 19 -4.6 4.8 1.5
Diversified International 21.2 6.3 9.8 8.5
Emerging Markets 27.5 8.5 -3.2 -3.8
Medical Delivery 23 21.3 6.6 8.4
Excerpted from the September 2005 issue of Jim Lowell’s Fidelity Investor . Click here for more of Lowell’s insights and analysis of Fidelity funds, and to subscribe to Fidelity Investor.

2. Manager Changes Aren’t Accounted For

Over the five years ending in 2005, there were more than 50 manager changes at Fidelity, and this is consistent with the average manager turnover rate in the fund industry.

Yet, rating agencies like Morningstar employ systems based on past fund performance rather than the individual manager’s performance history. So, even though the manager who may have been responsible for the actual performance of the product may no longer be running the fund, the funds may continue to use those ratings to promote their fund products.

Jim Lowell questions whether there might be an increase in manager turnover as many younger guns or experienced hands take the opportunity of their glowing short-term numbers to advance their careers by moving to a new fund family, or jumping from mutual funds to hedge funds, or from retail funds to institutional ones.

Bottom Line: Put 3- and 5-year “rankings” in perspective and read the fine print.