You have probably heard of the saying “Buy term, invest the difference” when getting insurance and putting your money in investments. But do we really comprehend what it actually means? What could be the reason why majority of financial planners strongly recommend that you should “buy term and invest the difference” ? On the other hand why is your insurance agent forcing you to buy his or her recommended product?
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.
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.
To evaluate whether or not she should continue paying the P200,000.00 we will evaluate the benefits of the insurance product versus the “Buy term, invest the difference” option.
If you add the total money that my sister will be receiving, she will get a total of P1,520,000.00 at age 65, that is if she opts to get the lump sum at age 65, plus she is insured for two million pesos.
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 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.
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 guaranteed 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 !!!
Would you like to know 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
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