If you ask any Indian above the age of 30 if they have insurance, they’ll say, “Yes, I have a few LIC policies.” If you ask them what insurance cover these policies give them, they’d probably answer with a paltry amount and if you ask them what premium they pay for this tiny amount, it would be usually a huge amount.
If you prod a little further and ask why they bought the LIC policy, they’d probably have 2 answers: “A close friend/neighbor/relative sold it to me” or the worse one, “It gives me insurance with investments”. And that there, my friends, is LITERALLY the worst financial mistake Indian families make: Mixing investments with insurance.
The sin of mixing insurance with investments has been passed down from generation to generation in Indian families like a secret recipe. And generations have followed this secret recipe to blow up their investing opportunities. In the days of license raj and a closed economy of 60s, 70s, 80s, Indians may not have had other options, or atleast options that looked good enough to take on the risk. But the scenario has changed. The Indian economy has grown and the Indian equity scenario has vastly improved. Mutual funds are becoming more and more popular. But the ancient advise of “Take an LIC policy” is still muttered in the ears of innocent young Indians just as frequently as “Put your money in a fixed deposit".
What’s worse, even “educated” Indians who earn many times more than their fathers did, still end up buying insurance policies that give “guaranteed returns”. If you ask them why they did it, they make similar arguments as their fathers. “It’s easy because I get both investment and insurance”, “It helps me save taxes”, “It’s less risky than the stock market” and so on. The result is they keep on buying policy after policy from persistent agents (who are often people they know) and end up destroying any chances of wealth creation. They feel happy for that “fixed tax-free income” 25 years in the future all the while being ignorant of the fact that they would have much better off buying government bonds which are as safe as the sovereignty of their country.
Of course, I am not criticizing only LIC. LIC forms the bulk of the insurance market and has the most persistent agent network in the history of mankind but all insurance companies are culprits here. Every insurance company out there desperately wants to sell you that amazing Unit Linked Incentive Plan (ULIP) that will “not only give you insurance but also fixed returns”. ULIP plans are basically the plans that mix insurance with investments. These plans are pushed by their huge agent network and gullible Indians who are generally highly “risk-averse” end up buying these plans.
But are these so bad, you may ask? Is my rant an over-reaction?
Let me assure you this is not an overreaction. These plans are really that bad.
But why are they so bad?
There’s a whole list, friends. Let me elaborate:
First and foremost, ULIP plans have a large upfront cost. So when you purchase a plan, a large portion of your premium goes for various charges like fund management charges, administrative charges, premium allocation charges etc. This means that not even all your money goes into the supposed investment.
If that wasn’t enough, the investment portion of these schemes Is hardly anything to brag about. Most of these schemes have abysmal returns. They promise you “guaranteed returns” and often 8% is the interest rate they go by. For a country where millions put their money into a 7.1% rate PPF, the 8% number sells like hotcakes. Although, this guaranteed return comes a long time in the future. Not only that, these plans also promise an “annual income” which means every guaranteed bonus is coming in small bits many, many years in the future. What they don’t tell is the effect of inflation on these bonuses. If you actually sit to calculate the returns of these plans like you do for mutual funds, these plans give anywhere between 4-6% CAGR including all the bonuses and maturity amounts. This rate doesn’t even beat inflation which means you are probably effectively losing money. So much for “guaranteed returns”.
If you are thinking, “Ok, the investment part is bad, but atleast I am getting insurance.” Yes, you do get insurance but at what cost? Since these plans have an investment component, they have very high premiums with little cover. People are so scared to lose their money in term insurance plans that they are ready to pay exorbitant premiums on low return rates only because they will “get that money back”. You could get 10x higher coverage at 10% of the cost in a term insurance plan and invest the rest in an actual investing mutual fund.
If these reasons weren’t enough, another downside to these plans is their illiquidity. For many ULIPs, surrendering or cancelling the policy in the middle attracts huge penalty fees. You must continue paying up even after reading this article.
What can you do then?
Well, there are hundreds of options. Let me explain you in 3 simple steps:
1. Do not mix investment with insurance. They are both different things with different aims and motivations and must be kept away from each other.
2. Get a term insurance plan and a health insurance plan. Purchasing a term insurance ensures your dependents get something to manage their lives with upon your demise. Yes, you will lose the premium money if you don’t die during the tenure but it is a small price to pay for your family’s security.
Look at this way: Even if you lose that small premium in a term insurance plan, you can get that money back by investing the rest of your money in a mutual fund.
3. Invest sensibly. Your goal is to create wealth, and that doesn’t happen if you don’t even beat inflation. Read here to understand how you may start investing if you have only recently started. If you want tax benefits, choose ELSS mutual funds and a Public Provident Fund if you want “guaranteed” returns.
Bottom line:
Do not mix insurance with investments.
Just don’t.
Do anything else but that.
Phew!
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