Whole Life Insurance Vs. Bond Funds
Whole life insurance is considered a type of cash value insurance because it contains a savings component that grows over time. A bond fund is essentially a mutual fund that invests solely in bonds. Whole life insurance and bond funds make sense for certain investors. Understanding the traits, benefits and risks of these financial instruments can help you decide if either one coincides with your investment objectives.
Understanding How They Work
A whole life insurance policy is purchased from an insurance company. Unlike some other types of life insurance policies, whole life insurance allows you to build a savings component. The insurance benefit remains in effect for your entire life or until you stop paying your premiums. Whole life insurance does not contain a renewal feature, and premiums typically remain fixed. You can purchase a bond fund through a brokerage firm, which usually requires a minimum investment. Fund managers pool money from a variety of investors to purchase bonds held in the fund. A bond fund may invest in short- and long-term bonds from a variety of issuers, such as corporate, municipal and government bonds.
The value of a whole life insurance policy is twofold: a death benefit and savings component. Unlike a bond fund, a whole life insurance policy does not contain a cash value for at least three to five years after you start the policy. Some whole life insurance policies pay dividends, depending on the performance of the underlying assets. The value of a bond fund is determined by the performance of its underlying assets and the fund’s yield. The value is also affected by interest rates. When interest rates rise, the value of a bond falls. If interest rates fall, bonds increase in value.
An advantage of whole life insurance is the ability to take out a loan against the cash value of your policy. The death benefit remains as long as you pay the premiums, unlike term insurance, which expires once the term is reached. A primary advantage of a bond fund is diversification. A bond fund generally includes bonds with varying yields and maturity dates. Another advantage is that they are professionally managed by fund managers who typically understand how to research investments and know when to buy and sell securities.
Unlike a bond fund, you incur steep surrender charges if you cash in your whole life insurance policy early. The premiums for whole life insurance are much higher than other types of life insurance, such as term life insurance. According to Smart Money, the commissions and fees are also high. As with whole life insurance, you must pay fees when investing in bond funds, which can diminish your return. Another disadvantage is that you have no control over the fund because all investment decisions are made by the fund manager.