More fiction is written on excel worksheets than on word documents.
We can all recall some corporate presentation where the future projections in a business plan almost bordered on fantasy.
Getting a project or investment approved by showing a rosy future is routinely deployed in organisations across the world.
Similarly when it comes to selling financial products, probably more stories are made up about life insurance linked products than anything else.
Similar to having an emergency fund, having the right life insurance coverage is one of the 5 core components of a financial plan for corporate professionals.
So how do you find your way in the maze of life insurance policies that are pitched to you?
Here is how – All you need to do is to follow the below simple rule of buying life insurance.
Simple Life Insurance Rule – Buy Term, Invest the Difference
This rule states that you should only buy a term policy for your life insurance needs instead of expensive money back policies.
At the same time invest your savings (from lower premiums) into a separate investment product.
Is that too much to grasp?
Not to worry as I now explain this golden rule in some more detail.
The most basic type of life insurance is called term insurance. It is almost always the cheapest option in terms of the premiums you need to pay for it.
So How Does Term Life Insurance Work?
Let us say you want to insure your life for a certain amount (say 1 million) for the next 10 years. You pay a premium every year to the insurance company for this term insurance policy.
If something happens to you during these 10 years, your dependents will get the 1 million (insurance amount) from the insurance company.
However, if you are still around after 10 years you will get nothing back. Yup, all those premiums you paid for 10 years is money down the drain.
And yes that sucks!
This in turn becomes the main selling point for a greedy insurance salesperson.
We hate to spend money if we get nothing in return.
The insurance companies and salespeople know this feeling very well. Therefore they try to sell you a life insurance policy that gives you “some” money back if you are still around after 10 years.
These money back policies are called by various names like whole life, endowment or some other fancy terms.
They all have something in common – They satisfy your need to get something back at the end of 10 years.
Here is the thing though:
The comfort of getting “some money back” at the end of 10 years will come at a very high price.
The annual premium that you pay for a money back policy will be many times the cost of a simple term insurance.
The true cost of a money back policy is hidden behind complex policy documents. Most people would have a real tough time trying to figure it out.
So is it possible to have the benefits of a low cost term insurance policy and also get some money back at the end of 10 years?
Yes! There is a simple way to do that.
Invest the Difference
Let us say the annual premium you need to pay for term insurance is 100. By comparison, the annual premium that you may need to pay for a money back policy could be 300 (or even higher).
Now take this difference of 200 (300-100) and invest that in a mutual fund (or even a bank fixed deposit if you prefer).
Over the course of the next 10 years this 200 will keep growing. Even at a rate of 7% per year this 200 will turn into more than 400 by the end of 10 years.
This 400 would be way more than what a regular money back life insurance policy would return to you at the end of 10 years.
(Based on real life examples some money back policies have given a return of as low as 2% only)
Yes – You can have your cake and eat it too!
How Does This Rule Help
Having adequate life insurance is essential to take care of your current and future financial obligations.
But a life insurance policy should only be used to cover the financial risk to your dependents in case something were to happen to you.
If you are still around after 10 years that in itself will be a great outcome for you and your family.
In addition you can enjoy the investment returns from the premium savings you had invested. It will also help you overcome the regret of paying annual premiums for your life insurance policy.
Expensive financial mistakes are made when we start treating life insurance policies as an investment that generates some return.
Trying to combine the two into a single product may be good for the insurance company and the salesperson but not for your financial wellbeing.
The golden rule of buying term insurance and investing the difference can help you meet you insurance as well as your investment objectives.
That too in a smarter and cheaper manner.
Insurance and investment are two different financial concepts and should always be treated as such.
When it comes to cases of corporate employees buying unsuitable financial products, life insurance policies routinely rank near the top.
Our lives by its very nature are uncertain as we don’t know what tomorrow holds. The life insurance industry has intentionally made some insurance products hard to understand for the average consumer.
They have come up with a maze of complex insurance products that most corporate professionals would do well to stay clear of.
There is a good reason for it – The more complex the product, the more profitable it normally is for the insurance company and the salesperson selling it.
By following the simple rule of buying life insurance, you should be able to avoid making expensive mistakes when picking an insurance product.
Buy Term, Invest the Difference.
Dushyant Choudhary is the founder of dushyantnomics, an early retirement blog for professionals. Dushyant retired early from his 9-5 corporate life after a successful international career. He brings his knowledge and experience to his current role where he’s dedicated to helping professionals achieve a fulfilling retirement.