Buying Term And Investing The Difference

I am sure that some of us has heard of the saying “Buy term, invest the difference” when buying insurance and investment products. However do we really understand what this means? So why do most financial planners recommend that we should “buy term and invest the difference” while some insurance agents keep on bugging you to get their 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.

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.

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.

I told her that we in order to determine whether she will continue paying the P200,000.00 we have to evaluate the benefits of the insurance product versus the “Buy term, invest the difference” scheme as suggested by most financial planners.

The total money that my sister will be receiving under the insurance scheme is around P3,520,000.00. This is derived from the P 40,000.00 she will receive per month until she reaches 65. Add to this the P 400,000.00 she will receive lump sum during that age. We should also take into consideration that she is insured for P2,000,000.00 hence giving us total benefits of around 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+.

But what if her investments will incur losses ? That is no problem at all. She can just buy term insurance and renew it every time it expires anyway, term insurance is very cheap and affordable.

But where do you get 10 % return per annum? There are lots of them. Examples of these are mutual funds and directly investing in the stock market. The returns here are not guaranteed though. However historical data will show that the rate of return for mutual fund companies is always above 10 % per annum especially if invested in equities. Investing in the stock market always proves profitable. Even the most conservative investors here gets a return of not less than 10 % per annum.

Buying term and investing the difference certainly does make sense !!!

Want 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