“An Investment in knowledge pays the best interest”
“An Investment in knowledge pays the best interest”
26 Nov 2020by Pradeep U
During a casual get-together with three of my college friends last weekend, there was a debate between two of them on what lies ahead for Sensex now that 44k levels had been breached.
While one of my friends was optimistic about Sensex touching 50k in the next few months, another had a pessimistic view stating that a correction was now imminent. Both had their reasons supporting their theories. While I have come across such discussions time and again on various platforms, what caught my attention was the silence and possible disinterest of my 3rd friend.
When I asked him about it, he replied: "I am not bothered whether Sensex reaches 50,000 or 30,000 as I don't invest in equities at all".
Curious to know about his preferred mode of investment, I asked him “Then where do you invest?”
“I invest majorly in life insurance. I have a whole life policy of XYZ company, and I am paying Rs. 25,000 every month,” he replied.
His reply stumped me. On one side while he was losing out on the benefit of compounding his wealth by not investing in equity, on the other hand, he was investing in life insurance even though he was single and had no dependents.
Life insurance is a complicated subject, especially in our country. Many people buy it without understanding whether they really need it, and many who have dependents often have low or zero life insurance. It is also one of the most mis-sold products in our country where it is often sold as an investment product for achieving financial goals like retirement or planning for a child's higher education or simply wealth creation.
Life insurance is defined as a contract between an insurance policyholder (life insured) and the insurance company, where the insurance company promises to pay the designated beneficiary a sum of money in exchange for a premium, in the event of the death of a life insured.
Different types of life insurance policies in India
There are different types of life insurance policies offered by life insurance companies in India, such as:
Term life insurance:
This is the purest and the most affordable type of life insurance which provides coverage for death risk for a specified period. In the event of the death of the life insured, the sum assured amount is payable to the nominee in a lump sum or as monthly pay-outs.
Unit linked insurance plans (ULIPs):
ULIPs are marketed as a combination of insurance, wealth creation and tax-saving investment. A portion of the premium is partly invested in equity/debt funds, while the rest of the premium is for risk cover and policy management charges.
Endowment insurance policy:
Endowment insurance plans also offer a mix of insurance coverage and investment. In the event of the policyholder’s demise, the sum assured is paid to the nominee. On the other hand, if the policyholder outlives the policy term, the sum assured amount with accumulated bonus is payable to the policyholder.
Money-back insurance policy:
In moneyback life insurance policy, the policyholder receives a specified sum in intervals during the policy term as well as sum assured amount on death or maturity.
Whole life insurance policy:
This type of insurance covers the policyholder for his/her entire lifetime or up to the age of 100 years. Sum assured is payable to the nominee of the policyholder on death of the policyholder. In the event of the policyholder’s demise, the sum assured is paid to the nominee.
A child insurance plan is a type of insurance policy aimed at helping the policyholder create a corpus for child’s higher education, foreign education, marriage, etc. either in lumpsum or at pre-decided stages of child’s education.
As the name suggests, this type a retirement plan is designed to help the policyholder build a corpus over a period of time by paying a regular premium for taking care of his/her retirement.
Life insurance is not really an investment
The primary and most important objective of buying life insurance should be for protection against unforeseen situations in case you have dependents. Life insurance policies are not really an investment as they offer low returns as the premium paid is divided into three components such as for expenses, mortality and investment.
While life insurance companies offer different types of life insurance policies aimed at helping policyholders fulfil their different financial goals, the real objective of investing, i.e. generating good returns takes a backseat. The actual returns generated are in the range of 6-6.5% in the case of most traditional life insurance policies.
Two reasons why life insurance policies offer low returns
Firstly, as we saw above, the amount of premium paid is divided among three components such as for expenses, mortality and investment. So, the actual amount of investment from the premium you pay is significantly less.
Secondly, life insurance companies are bound by the guidelines issued by IRDAI under the Insurance Regulatory and Development Authority (Investment) (Amendment) Regulations, 2001 which controls the degree of the investments by life insurance companies.
As per the regulations, life insurance companies must invest not less than 50% of in government securities and other approved funds. There are several such investment regulations as per the IRDA Act to ensure that policyholder’s money is not at risk.
If you have dependents and wish to secure them financially, it would be best choosing a term insurance plan which is not only the purest form of life insurance but also the cheapest.
A term insurance policy for a risk cover of Rs. 50 lacs for a 30-year-old non-smoker for a term of 30 years can cost anywhere between Rs. 5,500 to Rs. 9,000 per year depending on the insurance company chosen. On the other hand, the average premium for an endowment plan of Rs. 50 lacs sum assured for term 30 years comes to approximately Rs. 13000 per month or Rs. 1,56,000 per year.
Now assuming if you purchase a term plan for Rs. 50 lac rupees by paying a yearly premium of Rs. 9,000 and invest the difference of in direct equity the total corpus generated at the end of 30 years would be huge. For example, if you invest Rs. 12,500 per month in direct equity, assuming an average yearly return of 15% the value of your investment at the end of 30 years would amount to a whopping Rs. 8.65 crores.
Imagine if the kind of returns your investment would generate if the rate of returns is much higher at 25% or 30%. Yes, such equity investments are capable of generating such impressive returns when one remains invested in quality businesses for the long term due to the power of compounding.
Research & Ranking's own model portfolio has delivered 480% returns as compared to 68% returns delivered by the Nifty over the last five years. You can check it out here.
For your investment needs, equity can be your best bet. There is no doubt that equity investments carry a higher risk due to market volatility, but are stable over long periods. Depending on your age and the time duration for investment, you should allocate a portion of your investment to equity as it is the only investment which can not only beat inflation but also generate high returns.
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