Quiz!
Which of the following is typically true?
- It is best to buy insurance for most risks for peace of mind.
- It is best to avoid insurance and invest money in stocks, because stocks grow fast and can be used to cover the otherwise insured risks.
- It is best to insure against devastating risks.
- It is best to insure against non-devastating risks, and buy stocks to handle devastating risks.
Insurance vs. Diversified Stocks
The table below presents a basic comparison between diversified stocks and insurance. The first two rows show similar benefits, while the remaining rows show where each approach shines.
| Topic | Diversified Stocks | Insurance | Comments |
| Distribute risk at any point | The growth of 1,000 stocks overshadows one company’s bankruptcy. | By pooling 1,000 homeowners, the premiums paid cover the cost of one flooded house. | Both help diversify risks at a given instant. |
| Distribute risk over time | The growth of stocks over a full cycle overshadows the decline periods within the cycle. | The premiums paid by a large group of homeowners over time cover hurricane damages to a large group of homeowners. | Both help diversify risks over time. |
| Devastating risks | House burns down without big money saved => bankruptcy. | House burns down => covered by insurance. | Insurance is critical for covering risks that would devastate you. |
| Non-devastating risks | Can sell from stocks to cover the low risks. Otherwise, the saved insurance premiums that are invested in stocks are likely to grow dramatically over a lifetime. | The insurance premiums are lost. | Stocks are typically more beneficial for risks that are not devastating. |
| Availability | The money is available for you at all times, without being at the mercy of an insurance company, but the value will be lower during stock declines. | Claims can be declined for various reasons. | Insurance: Read carefully the exclusions list for insurance, and have money set aside for declined claims. Stocks: Have plenty more than the self-insured amounts, to account for stock declines. |
| Negotiated pricing | Not applicable | This applies for some types of insurance. Health insurers negotiate lower prices. | You get negotiated healthcare costs even with high deductible health insurance, in case this item tips the scale for you. |
| Risk of under-treatment | Risk of avoiding treatment that would otherwise be covered by insurance. | Having low-deductible health insurance can encourage treating high-risk problems that seem minor at first | If choosing self-insurance using stocks (e.g. by having high-deductible health insurance), be careful to not avoid necessary treatments that you would get with low-deductible insurance. |
| Overhead | No overhead | Insurance involves administrative costs and profits to the health insurer, that you pay for. | Unless you are a high risk person for using the insurance, your overall average cost may be higher with insurance. |
Quiz Answer:
Which of the following is typically true?
- It is best to buy insurance for most risks for peace of mind.
- It is best to avoid insurance and invest money in stocks, because stocks grow fast and can be used to cover the otherwise insured risks.
- It is best to insure against devastating risks. [The Correct Answer]
- It is best to insure against non-devastating risks, and buy stocks to handle devastating risks.
Explanations: Read the article for explanations.
Disclosures Including Backtested Performance Data