To invest or not to invest, is that even a question? It’s a well-known fact that when you invest, your money works for you by making you wealthier over time. Investing isn’t entirely about getting rich. It’s about building a financial safety net for yourself and your loved ones, because let’s face it, at some point in your life, you’re going to retire. Investing will help give you the financial freedom and stability you and your loved ones need when the time comes.
As far as investments go, there are a vast array of financial institutions as well as financial instruments to meet every investment requirement from wealth creation to general savings. Financial instruments are assets that can be traded, or they can also be seen as packages of capital that may be traded in the market1 such as money market investments, company stocks, bonds, real estate, etc.
Do you also consider life insurance an investment instrument? If you do, how critical is life insurance as an investment? Should life insurance replace the other financial instruments in your portfolio?
The truth is, for those who are wise, both solutions are excellent and can be used to hedge against different contingencies that may arise in the course of living. The questions to ask then are; how can one profit from both solutions and how cost-effective will the adoption of both solutions be?
So, let us try to resolve these queries by first defining the two concepts:
What is Life Insurance?
Life insurance is a legal agreement between a person and an insurance company. As per this agreement, the policyholder must pay regular amounts of money known as premiums, to the insurer. In exchange, the insurance provider must pay a predetermined sum of money, known as a benefit, to the beneficiaries of the policyholder in the event of the latter’s demise.
What is an investment?
The term ‘investment’ is used when an individual allocates money with the expectation of receiving a benefit sometime in the future. With financial instruments such as fixed deposits or mutual funds, a certain amount of money is invested with prospects that with time, it will reap the benefit of growth, due to accumulating interest.
Now, let’s look at the advantages and disadvantages of each solution.
Investments versus Life Insurance
Investments generally involve setting down funds with an investment company for a defined period after which the said funds are returned (or reinvested) along with a predefined investment return1. Depending on the investment type, there are varying degrees of risk, with the rate of investment return increasing as the risk increases.
So, generally, while investments may offer higher returns, they also come with a far higher risk of loss. Many investment instruments also offer very little or no guarantee on the safety of principal and /or interest amounts and are thus not ideal as stores of value for loved ones. The exception to this might be real estate investments which of course have their own unique drawbacks and government bonds (treasury bills) which are generally secured by the sovereignty of a government.
Life insurance on the other hand is essentially a longer-term financial protection and/or savings vehicle which gives insurance policy holders the means of protecting the financial wellbeing of loved ones2. Whether as a ‘pure risk’ or ‘investment linked’ policy, life insurances offer a guaranteed form of protection for loved ones whilst also offering some investment returns, albeit at lower rates than regular investment instruments3. In essence, it can be stated that while investments take care of now and the immediate future, life insurance looks after the much longer term4.
Life Insurance as an Investment
When deciding whether life insurance is a good investment, it's important to understand the types of policies you can purchase. There are several variations of life insurance plans, but they generally fall into two categories: permanent and term.
Life insurance plans offer more than just financial coverage to your beneficiaries. They also offer a variety of features that allow you to customise your plan and extend the coverage provided by your policy:
- Provides effective tax saving benefits.
- It covers you against financial risks in times of critical events. You can fall back on these funds when you are unable to earn money due to health problems.
- In event of your death, insurance can also help your family or dependents to alleviate financial expenses. A term insurance policy secures your family when you are not around.
- Endowment policies also act as a savings instrument as it provides the dual benefit of ensuring your life as well as being an investment instrument. Hence, if the policy holder survives the term of insurance, the entire amount is paid to the policy holder.