I am sure that some of us has heard of the saying “Buy term, invest the difference” when buying insurance and investment products. However do we really understand what this means? So why do most financial planners suggest that we should “buy term and invest the difference” while some insurance agents keep on bugging you to get their recommended product ?
Most financial planners would tell us to stay away from whole life insurance products as they’re considered rip offs. These kinds of products are not so popular anymore in the United Says. In order to fully understand “whole life” versus “term” they’re differentiated as follows: Term insurance refers to life coverage only while “whole life” refers to term policy with an investment scheme. Insurance agents usually present whole life insurance as something that will help you save for your retirement. Forcing you to save is probably something that is good for you, however the bad thing about this is that the returns for the investment in whole life insurance is very low. It is a pity that these type of products are still sold in the Philippines. Sadly, people still buy them because of inadequacy of financial knowledge.
To fully comprehend this, let me give you an example. The other week, my mom asked me if she should continue paying a certain type of insurance product that she purchased for my sister. It was worth about P 400,000.00 (Philippine Peso) the balance left is P 200,000.00 as she has already paid half of it.
I asked her what the benefits of the insurance product were. She said that after 20 years, my sister who is still 18 years old will receive P 40,000.00 per year until she reaches the age of 65. At the age of 65 she can choose to receive P400,000.00 lump sum. If she chooses not to receive the P 400,000.00 lump sum, she has the ability to select to continue receiving P 40,000.00 for the rest of her life. Plus she’s also insured for two million pesos for the rest of her life.
I told her that we in order to determine whether she’ll continue paying the P200,000.00 we’ve to evaluate the benefits of the insurance product versus the “Buy term, invest the difference” scheme as recommended by most financial planners.
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 receive per month until she reaches 65. Add to this the P 400,000.00 she will receive 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
Under the “buy term invest the difference scheme” since she has already paid partially for the insurance product she will convert what she has already paid into “term insurance” (That is if the insurance company grants it) This is usually good for only 20 years. The P 200,000.00 will then be invested at a automobile of investment that gives about 10 %+ return per annum. The profits derived from the ivnestment will also be re-invested in order to take full advantage of compounded interest. If she faithfully does this until she reaches the age of 65, she will get an estiamted P17,639,497.05.
Now see the difference !!! Under the insurance scheme you only get P1,500,000.00 and P 2,000,0000.00 worth of insurance. But in the “buy terms invest the difference strategy you get P 17,000,000.00+ !!! The benefits of the insurance product cannot be compared to the benefits under the purchase term invest the difference startegy.
Insurance protection is no problem. Term insurance is very cheap. In order to be protected if ever her investments will suffer losses, she’ll just buy term insurance an renew it each now and then.
But where do you get 10 % return per annum? There are lots of them. Examples of these are mutual funds and directly investing in the stock market. The returns here are not guaranted though. However historical data will show that the rate of return for mutual fund companies is always above 10 % per annum especially if invested in equities. Investing in the stock market always proves profitable. Even the most conservative investors here gets a return of not less than 10 % per annum.
Buying term and investing the difference certainly does make sense !!!