Written By — David Shafer
I recently had a call from a young man who was interested in an EIUL. During discussions he kept going back to mutual funds and the fact he thought he could purchase one’s that had very low expenses. Finally, he simply asked how could an EIUL [with its expenses] compete with a mutual fund that had an expense ratio of .18%?
I explained to him the three fundamental flaws in his questions and thought they might help the readers understand the attraction of EIULs.
1. He was comparing apples and oranges. EIULs use a stock index as a benchmark for the interest credited each year, but is not invested in a stock index. The fact is that the investments behind the EIUL crediting policy are a combination of fixed rate interest bearing instruments [in order to cover the minimum guarantee of 3%] and European style options on the index. To properly evaluate an EIUL you can either look at the history of this type of investment mix or the history of EIUL returns. You then compare this to the pure stock index returns. When you do this you see going back up to 30 years an advantage for the EIUL strategy of up to 1%.
2. At the end of the day, it is not total value of account that matters, but how much usable income that total value can produce. So to make a comparison you have to also look at taxation [both taxes avoided directly and indirectly like social security], and total returns including the insurance component of EIULs. I have gone over these issues with readers before so I won’t go over it again in this post.
3. Sequence of returns is incredibly important if you are thinking about using those funds for an income stream. Most of us have some time limits with which we operate under and the sequence of return problem can create havoc with the timing of withdrawals.
There are of course more advantages to the EIUL, which I have talked about, but these are the three main ones. And of course, you can construct a scenario where the mutual fund out-performs the EIUL. Mutual fund sales people do this all the time giving a rosy view of returns, how long one lives, and using those graphs that only go up [average return graphs]. The further we get away from that serious outlier of returns [1980-2000], the harder it is to make mutual fund returns seem risk free and the more other strategies like real estate investing and EIULs appear more logical and a better way to create income. What is always interesting to me is when I read about the pre-1980 investment styles and see that the wealthy used two important investment ideas.
Keep taxes low and focus on income streams.
If you do that, you will find yourself in a great position for retirement.
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