Mirror Fund What It Means How It Works Downsides
Mirror Fund: What It Means, How It Works, Downsides
Anthony Battle is a CERTIFIED FINANCIAL PLANNER™ professional. He earned the Chartered Financial Consultant® designation for advanced financial planning, the Chartered Life Underwriter® designation for advanced insurance specialization, the Accredited Financial Counselor® for Financial Counseling and both the Retirement Income Certified Professional®, and Certified Retirement Counselor designations for advance retirement planning.
Contents
What Is a Mirror Fund?
An insurance provider creates a mirror fund to replicate the performance of a high-quality mutual fund. These mirror funds are investment options for a variable life insurance policy.
The method allows policyholders to invest in mutual funds without directly investing in the market. Also, the policyholder may avoid the minimum acceptable investment by accessing the fund through the insurance company’s mirror fund.
Understanding Mirror Fund
A mirror fund often accompanies variable universal life insurance (VUL) products. Variable life insurance is a permanent life policy with a separate investment account. The investment account may include various investment instruments, such as stocks, bonds, equity funds, and money market funds. The tax-deferred performance from the investment account will add to or deduct from the death benefit. Premiums paid cover administrative fees and the management of the investment account. Policyholders must undergo full medical underwriting.
Frequently, the funds available for the investment portion of this type of life insurance are mirror funds. The insurance company creates an in-house fund that attempts to mirror or replicate the investments and returns of the underlying mutual fund, such as Vanguard, J.P. Morgan, BlackRock, and others.
All mutual funds have fees and expenses, which reduce the overall annual returns. The fees of mirror funds exceed those of the underlying fund. Also, these policies have a limited number of funds available for the investment portion, usually three to five.
The Downside of a Mirror Fund’s Cost
A typical mutual fund charges 1.5% to 2% in management fees. An investor who purchases a mirror fund usually pays higher fees. In some cases, an investor who buys a mirror fund through an insurance company is likely to have to pay a broker or independent financial advisor on top of the management fees. This added cost means that the investor’s return on the mirror fund is significantly lower.
Also, a mirror fund tends to lag behind the performance of the underlying funds. Since these are replications of the underlying fund, the provider must move into and out of holdings at a later date than the mutual fund. The difference in returns between directly holding the underlying fund and the mirror fund becomes more significant the longer the policyholder holds the investment.
Policies with mirror funds advertise as giving the policyholder access to high-quality, third-party funds. However, the policyholder is usually able to invest in the same high-quality mutual funds directly. The only limitation the policyholder may have is the minimum investment requirement of the high-quality mutual fund. Also, for direct investment, the policyholder will need an account with a broker such as Schwab or TD Ameritrade.
Not all insurance providers use mirror funds. Those who do not offer a selection of 50 to 100 approved investment vehicles. Providers allow investment in non-mirror funds, limiting where the policyholder may invest the dollars to only the most secure funds. Consumers should be aware that some policies may place a limit or cap on annual gains, which may add to the death benefit.
Equity Indexed Policies are Another Choice
Equity-indexed universal life insurance is also a type of permanent life insurance policy that has the opportunity to place the policy’s cash value in an equity index account. The separate account pays interest according to a market index without actually investing the money in the market. Some insurance providers may also offer mirror funds that replicate the index. As with the copycats of mutual funds, these index mirrors will charge additional fees.
