Cash on the Sideline? Here’s an Alternative

When most individuals and families think about investing, they usually think of conventional investment vehicles such as stocks, bonds, mutual funds, ETFs, etc. Rarely do we hear people bring up investments such as non-traded REITs (Real Estate Investment Trusts) or BDCs (Business Development Companies). Investments like these, known as alternative investments, are not typically correlated to the “market” (meaning there’s less propensity to move with the equity and fixed income market). These types of investments tend to be stable-value and income producing. In addition to offering steady income to investors, the addition of alternative investments to an individual's portfolio could even reduce the overall risk of the portfolio while increasing the long-term performance at the same time.

In the past, and the reason most investors are not typically familiar with alternative investments, these opportunities were not readily available to “retail” investors. The minimum investment required at times created barriers to entry, not uncommonly requiring investments upward of $50 million or $100 million to participate. The retail investor now has the ability to invest thanks to companies who have figured out how to pool investors' dollars and create offerings where capital raises of the required $50 million, for example, can take place to fund the investment.

So that is where we are headed in today's post, and hopefully you can begin to see why in situations where it makes sense, we really like the use of alternatives in our clients' portfolios.

We LOVE EFFICIENCY, in case you haven't figured that out yet after reading our previous blog posts. Talk to our clients, and they will tell you that the word efficiency comes up in meetings all of the time. Steady, consistent income-producing assets, such as non-traded REITs or BDCs can offer a great opportunity for investors to take cash sitting on the sidelines and create additional assets for their families.

The Example
Here is a unique situation where the use of alternatives can be powerful:

We recently met with a couple who had cash that, in their words, was "sitting on the sidelines" due to the volatility in the stock market. After meeting with them and working through our planning process, we discovered together that they had two red flags in their plan. The first red flag was the diversification that existed across their investment assets, which included lacking exposure to alternative investment classes. This discovery pops up commonly when we review new clients' accounts for the first time.

The second red flag that popped out to us was that there was not an intentional strategy to address the rising costs of providing future long term care (in the event they needed care one day). We realized after totaling their assets up that if they needed some type of care one day, be it in-home or in a facility, their current assets would not be sufficient to cover the costs of even the average length of stay. The conversation led to the idea of Long Term Care Insurance and that this couple had in fact looked into this type of coverage in the past, but had not purchased a policy.

When we asked them why they had not decided to buy a policy, they cited the biggest reason as not being able to stomach the thought of paying a big premium every year, not knowing if they would ever use the benefit of the policy. Unfortunately, this "use it or lose it" idea prevents many people from venturing into the Long Term Care insurance market to protect their other assets. The end result is that there are millions of people whose "financial plan" is dependent upon them never needing care. These individuals have chosen to self-insure with the hope that their assets and/or their families will be sufficient to provide for them.

The Strategy
This is what we helped implement: The $60,000 cash that was earning basically nothing in a savings account funded an alternative investment that was paying approximately a 7 percent (though not guaranteed) annual distribution. This provided $4,200 a year in income with the $60,000 remaining stable (not fluctuating up and down like traditional stocks or bonds in the market).

The next problem we had to address was the long-term care concern and how to go about helping them without the "use it or lose it" traditional insurance being the solution.

We discussed a hybrid insurance policy where the "use it or lose it" fear is removed. There are currently companies that will issue permanent life insurance policies (medically underwritten) where in the event long-term care is needed will accelerate a percentage (typically 2-4 percent) of the death benefit on a monthly basis to the insured. These types of policies also build up cash value inside that can be accessed on a tax favorable basis if done correctly. From an efficiency standpoint, these types of policies can make a lot of sense to those looking to avoid the "use it or lose it" solutions. They pass the test because family or an organization the clients love and care about will benefit from the policy in one or more of three possible ways:

- If they need long term care at some point the policy will accelerate a percentage of the death benefit on a monthly basis. The pool of dollars available is bigger than any cumulative premium paid in.
- If the client(s) never need long term care, the death benefit will pass to the named beneficiary (person, organization, charity, trust, etc.) TAX-FREE.
- If the client(s) never need long-term care, and they decide that the death benefit is no longer important to them at some point, they can access the cash that has built up.

The Big Picture
By establishing a plan where there will be a benefit paid out to someone, the "use it or lose it" problem was addressed. The clients were able to take $60,000 cash that was essentially earning nothing, and with no out of pocket cost to them through the 7 percent distribution (though not guaranteed) from the alternative investment, pay the premium for the insurance. This immediately created an entirely new asset through a pool of money they now have through the insurance. In this example, the insurance policy had a death benefit/pool of money for potential long term care of more than $200,000.

This strategy may not work for everyone, but it might be worth exploring as part of your overall financial plan. 

Editor's Note: Caleb Huftalin, CFP® serves clients by specializing in thorough and objective comprehensive financial advice at Catalyst Wealth Management.