by Zigfred Diaz
Some of us has probably heard of the saying “Buy term, invest the difference” when it comes to buying insurance and considering investments. But do we really understand what this means? And if we do understand what this means, why do financial planners recommend that you buy term and invest the difference while your insurance agent is pushing you to buy their recommended product instead.
The majority of whole life insurance products available today is tantamount to “rip offs.” In fact, these kinds of products has already been phased out in the United States. When we talk about “term insurance“, this refers to insurance with life coverage only. On the other hand whole life insurance is a term policy coupled with investments. Your insurance agent will always present whole life insurance as something that will “force” you to save for your retirement. This is actually good, but the problem with this setup is that most insurance companies do not usually give a good rate of return for the “investment” component. Sad to say, whole life insurance products are still actively sold in the Philippines. People still buy these products because of lack of financial know-how.
In order to fully understand this, let me give you an illustration. My mother asked me if she should continue paying an insurance product that she bought for my sister. The insurance product was worth about P 400,000.00 (Philippine Peso) She already paid half of it so the balance left is P 200,000.00.
In order to weigh the pros and cons of the product I asked her to tell me what the benefits were. According to her, the benefits are that after 20 years, my sister (still 18 years old as of this time) will receive P40,000.00 per year until she reach 65. At the age of 65 she can choose to either receive P400,000.00 lump sum or continue receiving P 40,000.00 perpetually. She is also insured for two million pesos.
To determine whether she should pay the remaining balance of P200,000.00, the benefits of the insurance product must be pittied against the benefits of the “Buy term, invest the difference” strategy.
The total money that my sister will be receiving under the insurance scheme is around P3,520,000.00. This is derived from the P 40,000.00 she will recieve per month until she reaches 65. Add to this the P 400,000.00 she will recieve lump sum during that age. We should also take into consideration that she is insured for P2,000,000.00 hence giving us total benefits of around P 3,520,000.00
On the other hand, if we follow the buy term invest the difference scheme, if her insurance company will allow her, she will convert what she has already paid into “term insurance” which usually runs for only 20 years and then invest the P 200,000.00. If she will invest the P 200,000.00 at a vehicle of investment that gives about 10 % return per annum and also re-invest the returns of the investment taking full advantage of compounded interest at age 65 she will get a whooping P 17,639,497.05.
Now do you see the difference? What is P 1,500,000.00 vs. P 17,000,000.00+. Even if you add the insurance coverage that is only a mere P 3,500,000.00, it still cannot compare to the P 17,000,000.00.
Insurance protection is no problem. Term insurance is very cheap. In order to be protected if ever her investments will suffer losses, she will just buy term insurance and renew it every now and then.
You might be wondering what investment vehicle would give you 10 % return per annum? There are several of them out there. You can invest in mutual funds where returns can run from 10 % to 70 % or more. However these returns are not guaranted but historically the rate of return does not fall below 10 % per annum. (that is if they are invested in equities) You can also invest in the stock market. In the Philippines, a bullish stock market gives a high rate of return that even the most conservative investors in the stock market earns more than 10 % per annum.
Buying term and investing the difference certainly does make sense !!!
About the Author:
Zigfred Diaz blogs on making money online, SEO, investing, financial management, and other interesting topics. He has joined the Busby SEO Test contest. Check out his blog today at www.zdiaz.com
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