Knowing The Importance Of Buy Term And Invest The Difference

December 18th, 2009 | by Admin |

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.

In order to fully understand this, let me give you an illustration. My mother asked me if she should continue paying an insurance product that she bought for my sister. The insurance product was worth about P 400,000.00 (Philippine Peso) She already paid half of it so the balance left is P 200,000.00.

In order to weigh the pros and cons of the product I asked her to tell me what the benefits were. According to her, the benefits are that after 20 years, my sister (still 18 years old as of this time) will receive P40,000.00 per year until she reach 65. At the age of 65 she can choose to either receive P400,000.00 lump sum or continue receiving P 40,000.00 perpetually. She is also insured for two million pesos.

To determine whether she should pay the remaining balance of P200,000.00, the benefits of the insurance product must be pitted against the benefits of the “Buy term, invest the difference” strategy.

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)

Can you see the big difference? What is P 1,500,000.00 plus P2,000,000.00 insurance vs. P 17,000,000.00+.

Insurance protection is no problem. Term insurance is very cheap. In order to be protected if ever her investments will suffer losses, she will just buy term insurance an renew it every now and then.

The next thing you could probably ask, what investment vehicle would give me 10 % return per annum? Well there is and there are lots of them. You can put it in mutual funds. It does not guarantee a rate of return but historically most mutual fund companies give you more than 10 % return per annum especially if they are invested in equities. Now that the stock market is very bullish returns ranges from 40 % to more than 70 % per annum. You can even directly invest in the stock market. Even the most conservative investors in the stock market earn more than 10 % per annum.

Now you know why buying term and investing the difference does makes sense !!!

Would you like to know more about investment strategies ? Visit the blog of Zigfred Diaz where he blogs about several interesting topics such as investments, financial management, business, making financial online and Stock market investing

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