When building your finances, you cannot fully rely on only investments or only insurance. The two instruments together are the backbones of your financial plan.
Investments boost your wealth more than your direct income source. It provides you returns even when you are not actively working on your occupation. A well-planned portfolio can earn tremendous results. This comes in handy when you choose to save your hard-earned money and let it multiply.
Insurance, on the other hand, is a safety tool. The premium will not come back to you. It is to prepare a safety tool, which works as a backup for your dependents. Insurance is for your dependents’ life after your death, not for returns when you are alive.
And because of this, a general approach is that insurance premium is an expense, that ‘gets lost.’ You do not earn returns on it. This is true, but that does not mean you skip insurance altogether and use all your funds for investing, only eyeing returns.
Let us not forget that insurance is an equally important instrument to safeguard a part of our income to help our dependents down the line.
This has led insurance companies to create hybrid products (investment-cum-insurance schemes) catering to the market demand. Some of these seem viable, but the question that can tell you if it is indeed lucrative is this:
Simply put, no. Insurance is a tool for protection, not for profit. The newer schemes may be quite attractive. But the best, most economic, and most protective is term insurance.
Other policies, which are hybrid tools, charge a higher premium to earn more returns. However, with statutory compliances, insurance companies cannot invest the entire premium amount in the market to earn the returns you want.
They need to keep the premium away from risk. When the time comes, on maturity or in case of a claim, they can repay your sum without hassles. So, they invest only up to 8-10% of the premium in the market.
This limits the earning ability of insurance products. This means, using insurance as an investment tool entails a huge opportunity cost.
Let’s say you invest ₹1,000 in an equity fund, which gives you a return of 12%p.a. The whole of this amount is used to earn that return for you.
On the other hand, when you invest the same amount in insurance, only ₹100 from it is invested in the market. The rest is parked aside in a safe fund. Meaning, you are paying more, but not earning as much return.
So, if your goal, via investment or insurance, is to earn the same ₹120, you will have to pay a much higher premium and yet, remain underinsured. Because the hybrid products would give you a lower sum assured, as compared to a term cover, on the same amount of premium.
Therefore, insurance as an investment turns futile.
If you take a simple term insurance enough to cover your family/dependents for a certain period and invest the rest of your funds in another instrument, it will fetch you more than the premium alone.
It is also easier to manage term cover premiums, with tax benefits to a certain level.
Also read: Shares or Mutual Funds: which is better?
To give you higher returns, hybrid products need to invest in risky avenues. As an insurance company, it keeps your premium and sum assured safe. so that is ruled out. Minimal risk means low returns.
In hybrid policies, the major point of attraction is the future value, or the sum assured. What most people do not consider is the inflation rates and the rate of compounding. With a higher premium, not factoring in inflation, you end up insuring yourself for far less at a higher cost.
To understand this better, let us see how insurance works.
The premium you pay is used in three segments –
Remember, the purpose of insurance is not to make you rich or compound wealth. It is to manage survival for your dependents without you.
Then why do insurance agents push these hybrid policies more than term insurance? For higher commissions. Most investment/insurance companies offer a higher premium for hybrid policies, which pushes the agents to sell more of the higher-paying policies.
Also read: Contingency funds: 101
Investments and insurance are both for different goals and purposes, with their modus operandi.
Before you decide, make sure you compare what you expend/invest and earn in return.
The best idea would be sticking to a term cover, which protects your family. Look for other avenues for returns to celebrate life, life mutual funds, equity, etc.