Buying Term And Investing The Difference
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.
Most financial planners would tell us to stay away from whole life insurance products as they are considered rip offs. These kinds of products are not so popular anymore in the United States. In order to fully understand “whole life” versus “term” they are 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 drive home the point, let me give you an actual situation. Sometime last week, my mother asked me if she should continue paying an insurance product she got for my sister. The total price for it was about P 400,000.00 (Philippine Peso). Half of it is already been paid leaving a balance of P200,000.00.
According to her, the benefits of the insurance product are as follows; After 20 years, my sister who is still 18 years old will receive P 40,000.00 per annum until she reaches 65 years of age; At the age of 65 she can either choose to receive P400,000.00 lump sum or continue receiving P 40,000.00 until she dies, plus she is also insured for two million pesos for as long as she lives.
I told her that we in order to determine whether she will continue paying the P200,000.00 we have to evaluate the benefits of the insurance product versus the “Buy term, invest the difference” scheme as suggested by most financial planners.
Under the insurance scheme, the total benefits my sister will be receiving is as follows; she will get a total of P1,520,000.00 at age 65. Plus she is insured for P2,000,000.00 giving total benefits of P 3,520,000.00.
On the other hand the benefits of the “buy term invest the difference scheme” is as follows: The P 200,000.00 will be invested at a vehicle of investment that gives about 10 % return per annum. She will then re-invest the profits made through the investment in order to take full advantage of compounded interest. If she does this consistently she will get around P17,639,497.05 when she reaches the age of 65. As for the payment she already made for the insurance product, she will just ask the insurance company to convert what she has already paid into “term insurance.” This is usually good for only 20 years. (That is if her insurance company allows it)
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 buy term invest the difference strategy.
You might ask what about insurance protection? Take note that pure term insurance is very cheap. She can just buy term insurance and renew it every 20 years.
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 guaranteed 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.
Buy term invest the difference? It certainly does make sense!!!
Are you willing to learn more about investment strategies ? Visit the blog of Zigfred Diaz where he writes about several interesting topics such as investments, money management, business, making money online and Stock market investing
