Why Insurance should not be an Investment?
There are many investors who happily say they have so many life insurance policies and the maturity amount of each policy is twice or thrice of the total premiums paid. They are usually concerned with only one question while buying these policies, “How much will I get from it?” This is the case with most of the people in India. Do people really know the purpose of life insurance? And why do people buy insurance policies as an investment? We at Fpguru.com would like to clear some misunderstandings regarding this.
Insurance is a service purchased to replace any financial loss incurred by you due to any unfortunate event. For e.g. you can insure your car, house, health, property to replace the loss in the events of damage, theft, fire, accident, etc. You can even insure your life for those who are financially dependent on you. Remember that it is not to fulfill your child education expenses or post retirement expenses etc. Hence, the purpose of insurance is purely to replace financial loss.
Investment on the other hand, is what you hold and allow its value to grow and then sell it for consumption in future. Hence, one always invests at the best possible rate of return to fulfill future goals such as child education, dream vacations or retirement funding.
It’s not a good idea to mix the two!!
Let’s understand this by a simple example:
Mr. Tom & Mr. Jerry both aged 30, go to buy a life insurance policy for themselves. Mr. Tom opts for an endowment plan of 30yrs. with a life cover of Rs. 10 lacs at a premium of Rs. 32,000 p.a. On the other hand Mr. Jerry opts for the term plan providing the same life cover of Rs. 10 lacs and the same term of 30 years. but, at a premium of Rs. 3,700 p.a. only.
Now, the difference between the term insurance and the endowment insurance is that term insurance offers only insurance i.e. no money is paid if the insured survives the term. Whereas, in the endowment insurance plan a maturity value is paid at the end of the term if the insured survives the term of the policy.
Mr. Tom made fun of Mr. Jerry by saying that he would spend all that money and will get nothing in end. Mr. Tom felt proud that his endowment plan will provide him a maturity value of Rs. 29, 43, 655/- (i.e. return of around 7%).
Mr. Jerry explained that by taking a term plan he pays a premium of only Rs. 3,700 p.a. Hence, saving the extra premium of Rs. 28, 300 that Mr. Tom paid (32000-3700). Now, this extra premium he plans to invest in equity MF with an approx. return of 16%p.a. over 30 years. Hence, Mr. Jerry would earn much more than Mr. Tom’s endowment plan providing 7% p.a. returns and a maturity value of Rs. 29, 43, 655/-.
Mr. Jerry’s equity Mutual Funds will earn him a whooping sum of Rs. 1, 74, 09,073/- ! And not to forget a term insurance providing a life cover of Rs. 10 lacs also. All his purposes are fulfilled.
So, was it a right decision by Mr. Tom to choose insurance as an investment instrument?
If you are still tempted to use insurance as an investment, please also consider that the monthly contribution made in investment funds can be changed, whereas, the monthly premium for life insurance cum investment policies usually cannot be changed. A lower income group can have adequate life cover by opting for term plan and investing their balance savings to earn higher returns. Therefore, the two should not be mixed.
We at Fpguru.com suggest you to analyze your life insurance needs and then opt for a term plan of the appropriate amount while for investments you should consider your financial goals & time horizon. This will ensure your financial freedom in good times and otherwise!
By Disha Keyur Shah
The writer is working with FpGuru.com
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