The Most Authentic Guide on Personal Finance and Investments

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Don't Buy Insurance for Investment Purposes

Suppose you are a 30-year old person and want a life insurance cover of Rs.10 lakhs for a term of 20 years.

The usual tendency would be to buy an insurance-cum-investment policy (e.g. an endowment policy). Herein, your premium payout would be around Rs.45,000 p.a. for 20 years. Based on the average returns offered by such policies in the past, you can expect to get back about Rs.17-18 lakhs on maturity.

Alternatively, you could buy a term policy for a cover of Rs.10 lakhs for 20 years with a premium of just Rs.3000. Thus you save Rs.42,000 on premium, which you are free to invest as you wish. Suppose, you invest this Rs.42,000 in a PPF for 20 years. Now, at maturity you will get back Rs.20.75 lakhs (assuming average 8% returns from PPF). 

This higher maturity amount in PPF is due to the high charges built into the insurance-cum-invetsment plans that eat into the returns. Most stand-alone investment products have lower cost structure (sometimes even nil), which result in better returns than insurance policies.

Thus, while the term plan takes care of your insurance, the investment in PPF gives you a higher corpus at maturity. This is a like-to-like comparison as both PPF and Endowment plan are debt products, with long lock-in period and 100% safe tax-free returns.

However, when you have a choice, why should you restrict to debt product like PPF. In fact, the long time-period of 20 years and regular investment pattern, make an ideal combination to invest in equity. If you do so and equity delivers a reasonable 15% p.a. returns, your corpus on maturity would be almost Rs.50 lakhs. (If you do not want to take too much risk, you can always choose a suitable mix of debt and equity.)

Ok, so far we have discussed debt-based endowment, moneyback and wholelife policies. But what if you buy the 100% equity-based ULIPs?

These are no different from the mutual funds as far as the investment and risk are concerned. However, again it is the charge structure which makes the difference. The charges in ULIPs are generally front-loaded. Therefore, normally the returns from MFs will be higher than ULIP in the first 8-10 years. Thereafter ULIPs may break-even with MFs.

Therefore, if you are looking for debt-based investments, it makes sense to keep insurance and investment separate. Though you can expect to earn similar returns from MFs and 100% equity-based ULIPs, it still makes sense to keep insurance and investment separate due to various reasons discussed below.

In endowment/moneyback/wholelife policies, you have to complete the entire term. If you don’t and close the policy prematurely, you will have to pay heavily by way of surrender charges. Thus, once you buy such a policy, you are practically stuck with it. Instead, had you bought a pure protection policy, you could close it any time. Since there is no return-component involved, you would lose nothing. Even on the investment side, whether you invested in PPF, MFs or such other products, you would have had much more flexibility.

ULIPs have a lock-in of 5 years. Thereafter too, there may be surrender charges. On the other hand there is no lock in most MFs and the exit load, if any, is generally up to 1 year. Thus, with ULIPs too you get much lesser flexibility to change your investments if so required.

In insurance plans you have to necessarily pay the same amount year after year for decades. What if in some particular year, you cannot do so? You could lose heavily if you don’t pay your insurance premium. But in most pure investment products there is no such compulsion. You can vary your investment year after year if you so desire.

[From wealth creation perspective, however, this is not advisable. You should ideally be a disciplined long term investor. This option is only if you are experiencing some financial difficulty in making the investment.]

In insurance-cum-investment policies, you have to make investment in the same policy. Your fortunes are thus linked to the performance of just one fund. However, if you buy pure investment products, you can buy different products every year with the same money and thus create a diversified portfolio.

Hence, for greater transparency, flexibility, liquidity, simplicity, convenience and better returns it is generally recommended to keep the insurance and investment separate.

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