I accidently met a friend after long .. we sat for a cup of tea & discussed many things under the Sun.
She told me about a flat they purchased recently. While she & husband opted for a home loan, they also purchased one ‘market linked insurance policy’. They were told that since you are now taking liabilities on your shoulder, it’s better to have insurance policy along.
When I asked more, I got to know that the amount of cover the policy was providing was far less than the home loan principal amount. They were told about the ‘returns’ the policy will potentially give them as it is ‘market linked’.
Now, it was my duty to explain her the difference between ‘Insurance’ & ‘Investment’ & why we should keep it separate?
How insurance & investments are different?
Many of us don’t acknowledge the basic difference between these two. This is the reason many seek ‘returns’ from their insurance policy.
‘Insurance’ is the assurance of ‘financial independence’ given to the dependents of the insured person. It helps them to live their life on their own without anyone financial help, maintain their standard of living & also fulfill their life goals.
‘Investment’ on the other hand, is a deliberate attempt to make our money work for us! When we ‘invest’ our money in any chosen instrument, we get relevant ‘returns’ on our money invested.
- We also carry tax implications, risk involved with investing in any instrument that we choose to.
- ‘Insurance’ helps us to protect ‘financial independence’ whereas, investments help us to be the one.
- ‘Insurance’ is never for the insured person, but for his/her dependents but ‘investments’ are for the person who makes it to achieve own & family goals.
Why we should avoid mixing insurance with investment?
- Complex nature:
Policies & products which offer mixed benefit of insurance & investments are complex to understand. When we talk about market linked policies, a part of the premium goes to ‘investing’ in a fund that investor chooses, other part goes to pay different charges like allocation charge & other goes to insurance cover.
A fund mix or a portfolio which a person chooses, is often complex to understand. Often, it’s a mix of debt & equity. Allocation to each of these asset classes can be changed if the person wishes but he/she cant track the performance of the investment made transparently & changing the allocation can be a task.
On the other hand, sum assured is never enough for the dependents if unfortunately, insured person dies.
Market linked policies have three broad types-
Type I: Upon death of the policy holder, policy pays higher of the sum assured or unit value of the investment to the nominee.
Type II: Upon the death of the policy holder, a nominee gets both, i.e. sum assured & unit value of the investment made in the policy.
Type III: They come in the form of ‘pension plan’ & it is linked to retirement age. Like above two types, upon the death of the policy holder, a nominee gets the death benefit but if the policy holder survives till the ‘retirement age’, then he is paid with the premiums paid so that he can use full amount to buy annuity.
Unlike retirement plans; endowment policies & money back policies are not linked to market. but, they do offer returns on the investment because if the policy holder survives the term, then he/she gets the sum assured along with bonus, as stated in the policy.
- Lock in period & withdrawal rules:
Every such policy which is market linked comes with a lock in period. Generally, its 5 years. A person can choose the premium paying period for the policy.
If the person wishes to withdraw from the policy, then he/she can-not do so within the lock in period.
If he/she discontinues paying premiums instead, then the accumulated corpus goes to ‘discontinuance fund’ where the corpus continues to earn return@ 4% p.a. Once the lock in period is over, a person can withdraw from the policy.
This often is a hindrance when you are in real need of money. You should not invest where there are restrictions on the access & withdrawal of your own money.
- High amount of premium applicable:
Premium that you pay on any such policy is generally on a higher side compared to sum assured you are entitled to receive. When you compare & understand, you will find that you are paying higher price for the sum assured you will get.
This is because a premium amount that you pay don’t go towards your insurance cover in full.
In case of market linked policies, a part goes to charges like allocation charges, etc, a part gets invested in a fund that you choose & remaining goes for your insurance cover.
In case of non-market linked policies, though you are not investing in any fund, a part of the premium goes towards charges, bonus etc & remaining goes towards insurance cover.
This way you pay higher premium amount for longer years.
- Sum assured is not inflation proof generally:
When a person buys any such insurance policy mixed with investment, he/she is supposed to get returns in the form of ‘sum assured along with bonus, fund value of the investment’ if he/she survives the term.
Money which goes on for paying the premium for a period generally ranging between 5 to 20 years is higher in comparison with the amount a person will receive upon surviving the term.
Also, it will not be ‘inflation proof’ when receivable in future as ‘real rate of return’ on the investment is generally negative or far less.
A typical simple endowment plan gives returns in the range between 6%-8% for a period of 15 years.
- Tracking of investment is not easy:
When a person buys any market linked policy, he invests a part of his money into a portfolio of funds that come along with the policy. Many policies offer freedom to choose a fund from available options like equity, debt & a mix of both.
But this investment made is difficult to track. One can see the fund value but freedom to change the portfolio, performance of the fund can be difficult to track.
I always insist on the fact that, ‘money’ should work for us but also it should be invested in such a way that gives us a freedom to access our investments, it is available when we need it & most importantly it serves the very purpose of our actual goal.
When we keep ‘insurance’ & ‘investment’ separate from each other, they work better for us!