An Integrated Investment Plan Is Key

A sound investment plan isn’t the only way to find financial security.


Earlier this week, we looked at the importance of incorporating different types of risk—specifically, human capital risk—into an overall financial plan. Today I will focus on mortality and longevity risk, and using “tax alpha” strategies to improve the odds of achieving your financial goals.

Mortality Risk

For those families whose human capital makes up a substantial portion of their total assets, protecting that capital via the purchase of life insurance should be part of the overall financial plan. Life insurance is the perfect hedge for mortality risk because its return is 100% negatively correlated with the human capital asset.

The younger the investor (the higher the human capital), the greater the need for life insurance. The amount of insurance required can be determined through what’s called a “needs analysis.” It can also be related to bequeathal motivations.

It’s important to note that life insurance can be used for purposes other than to hedge mortality risk. For example, it may be the most effective way to pay estate taxes. It can also be useful in terms of business continuity risks. Thus, while the individual’s need for insurance to hedge the risks of human capital falls as he or she ages, the need for life insurance might actually increase.

Longevity Risk

Longevity risk is the risk that you will outlive the ability of your portfolio to support your desired lifestyle. This risk has increased for much of the population with the decline of defined benefit plans (which, like social security, pay out for a lifetime) in favor of defined contribution plans. Also, advances in medical science continue to expand life expectancy. Longevity risk can be addressed by the purchase of lifetime payout annuities.

While the academic literature demonstrates that many investors would benefit greatly from the purchase of immediate annuities or deferred income annuities (because of “mortality credits” built into the product—in effect, people who die earlier than expected subsidize those who live longer than expected), very few are purchased.

The main reason seems to be that people are risk averse, in the sense that they don’t want to risk giving up their assets and then dying soon. The fear is that the assets would no longer be available for their heirs. But this is only true if they live a shorter-than-average life span. By definition, half will live longer. And for them, buying a payout annuity preserves any remaining assets for the estate.

The academic literature suggests that deferred income annuities are superior to immediate annuities for the purpose of protecting against longevity risk. Deferred income annuities can be purchased in an investor’s mid-60’s, with income beginning at age 85. Investors should begin to consider purchasing immediate annuities during their mid-70’s and buy them before they reach age 85.

Since the payouts from annuities are dependent on the level of interest rates (among other things), a recommended strategy is to diversify the interest rate risk by purchasing various annuity contracts over time instead of all at once. This strategy also preserves liquidity for some period. Monte Carlo simulations help analyze the benefits of annuitization. It’s also important to understand that delaying social security benefits as long as possible provides longevity insurance.

Another risk is also related to longevity. As we age, the risk of needing some form of long-term health care increases. It’s estimated that at least 60% of people over age 65 will require some long-term care services at some point in their lives. And contrary to what many people believe, Medicare and private health insurance programs do not pay for the majority of long-term care services most people need—help with activities of daily living, such as dressing or using the bathroom.

Thus, when investors develop an overall financial plan, they should consider the purchase of long-term care insurance. Again, the use of Monte Carlo simulations can help analyze how the purchase of long-term health insurance impacts the odds of achieving one’s goals.

These examples demonstrate why having a well-developed investment plan isn’t sufficient for financial planning purposes. Other important risks also exist. We need to consider another broad category called wealth protection.

Wealth Protection Insurance

Financial plans can fail in several ways because we don’t have sufficient insurance. A well-developed plan covers not only longevity and mortality risks, but disability.

Sufficient coverage should also be in place for all types of property and casualty risks, as well as the all-too-often overlooked personal liability risks covered by umbrella policies that protect against claims from lawsuits. Because needs change over time, incorporating a regular, thorough review of your overall insurance needs is an important part of the financial planning process.

In addition to integrating into an overall financial plan the management of the risks we have discussed, integration of strategies that add “tax alpha” can significantly improve the odds of achieving your financial goals.

Tax Alpha

Tax Alpha refers to the additional performance benefit gained from your investments through tax savings. Following are just two ways tax alpha can improve results:

1. You can take advantage of a lower tax bracket between retirement and the time that required minimum distributions (RMD) start to reduce the size of IRAs. Taking income at a low bracket early can lead to avoiding paying tax at a higher bracket later.

2. You can achieve proper asset location, holding lower returning assets (such as bonds) in a traditional IRA while holding higher returning assets (such as stocks) in a Roth IRA to keep future RMDs as low as possible.


Having a well-thought-out investment plan is a critical part of the financial planning process. However, it’s only the necessary condition for likely success. The sufficient condition is to integrate the investment plan into an overall financial plan that also addresses the risk management issues discussed above. Even then, other issues may need to be considered.

For example, for those with charitable intent, there are more, and less, efficient ways to make donations. The same is true for the transfer of wealth, whether through lifetime gifts, leaving a legacy or both. A well-thought-out financial plan helps to ensure that transfers to loved ones or to charity are made in the most tax-efficient manner, in a way that maintains the donors’ financial independence during their lifetime and meets their nonmonetary objectives.

If your planning doesn’t address each of these issues, I hope this serves as a wakeup call. It’s not too late to act—until it is.

This commentary originally appeared April 14 on

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