Some people may think that they are investing when they buy an insurance policy. Is insurance really a type of investment? Before we answer this, we take a look at the purpose of a life insurance policy and investment. This post will explain the difference between insurance and investment and what to look out for.
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What is Insurance?
Insurance is a form of financial coverage and protection in the event of an unforeseen circumstances that would cause you or your dependent some sort of loss. The insurance company or insurer will pay an agreed amount to cover for the loss. Example of loss may include but not limited to the follow:
- Total and Permanent Disability (TPD)
- Critical Illness (CI)
- Loss of belongings
- Damage to property
What is LIFE Insurance and its purpose?
Life Insurance is one of the 3 types of insurance (Life, Health, General Insurance). It is the policy that people may get confused with investment as some policies may promised returns in addition to coverage. But is that really its purpose?
Why Life insurance is named “LIFE” Insurance and not death insurance? If the life insured dies, the purpose of the payout is meant for the living that is left behind, to allow them a means to carry on with their everyday life instead of being in financial difficulties. In the case of Total and Permanent Disability or Critical Illness, the payout would allow the affected person to continue living, aiming to reduce the financial burden that would follow.
Thus the purpose of Life Insurance is for protection, protecting the family or yourself from financial burden in times of mishap.
What is Investment?
Most people would think that investment is mainly using money or resources to commit to an endeavour, hoping to generate income or profit in the future. It is to make more money for yourself when you are alive. However, there is more to it when considering if the investment is a sound one or not.
Factors to consider when investing:
- Beating Inflation
- Beating “Risk-free” bonds/schemes
Investment need to beat Inflation
We need to first preserve the value of capital. For example, $10 presently can buy 5 bread loaves. 5 years down the road, 5 bread loaves may require $12 dollars. So even if the investment “gained” 20% in 5 years from $10 to $12, it is just maintaining the value of the money.
Thus, when we invest, we need to make sure the returns exceed the cost of inflation.
Investment need to beat “Risk-free” bonds
There are bonds in the market, or schemes from government that guaranteed a certain percentage of interest if you invest your money with them. These bonds or schemes usually aims to beat inflation rates so there is no devaluation of our capital.
One example would be the money in our CPF account. The funds in our CPF-OA and CPF-SA account would generate risk-free interest of 2.5% and 4% respectively.
Thus if we were to invest our money in our CPF account, we need to ensure that the investments will gain higher returns, as compared to leaving the money in the respective accounts. If the investment is not going to have potential higher returns as compared to what the CPF board guarantees, then there is no reason to take the risk to get lower or same returns.
So is buying Insurance considered as an Investment?
Some people get confuse with insurance and investment. Reason being there are endowment (saving) plans that may provide death and TPD benefit. There are also Investment Linked Policies (ILP) that provide insurance coverage but at the same time having certain percentage of the premium paid used to do investment in funds. Thus, people end up thinking these policies do help them increase their capital while having some sort of protection.
These policies are also sold by an insurance company that provide all sorts of financial planning solution such as wealth protection, wealth accumulation and wealth distribution. So to most people, they may get a little confused. To them, anything bought from a insurance company is an insurance policy.
Even though there are policies that may allow you to earn money and have protection at the same time, we need to be clear that the purpose of insurance and investment is different. Insurance is to protect your wealth when you die or suffered from TPD or CI. Investment is to grow your wealth so that you can have more money or assets for your financial goals or retirement. Thus, buying insurance is not an investment, but putting money in wealth solutions from an insurance company can be an investment.
Which is more important, Insurance or Investment?
In order to have a sound financial planning, both insurance and investment is required.
If we only have insurance, we would be well protected from any mishap that happen to us. However, we have to continue working even when we are supposed to retire. When we stop working, our income would also stop. Do we really want that?
If investment is what we place all our money in, we would be having more capital for future use. However, we will be at risk of having a financial burden if a mishap struck us and the returns from the investment is not sufficient to cover the medical cost.
“Money no enough” is the common reason people give to themselves to not buy insurance or do any investment. Most of us would agree to that statement as money is never enough due to the daily needs and our wants. We would then need to have the discipline to prioritise our needs and wants. By doing so, we would be able to find that little spare cash. So if we manage to squeeze out the little spare cash, which to place in first?
For young adults who start earning money should consider getting insurance first. Most insurance policy would be enforced once approved, while investment require some time to obtain the returns. Money is also required for investment and we need to earn that money. But if there is a mishap and we could not continue to work, we would not have the money for investment.
We would have a peace of mind after we are well covered. We start to have more income and savings as we work, and could use these money in investment to generate higher returns.
Insurance is to protect our existing wealth and Investment is to grow our existing wealth. Both components are important to a financial plan and neither one should not be omitted. First we should get ourselves protected then proceed to growing our wealth.
If you have any other queries, you can message us and we would try to answer your questions. We could also recommend financial consultants to assist you with your financial planning if you wish to consult one.