In this edition of the reader story, we have an account of a reader making the classic mistake of combining investment and insurance, the price he had to pay. The reader wishes anonymity.
About this series: I am grateful to readers for sharing intimate details about their financial lives for the benefit of readers. Some of the previous editions are linked at the bottom of this article. You can also access the full reader story archive.
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If you would like to contribute to the DIY community in this manner, send your audits to freefincal AT Gmail dot com. They can be published anonymously if you so desire.
Please note: We welcome such articles from young earners who have just started investing. See, for example, this piece by a 29-year-old: How I track financial goals without worrying about returns. We have also started a new “mutual fund success stories” series. This is the first edition: How mutual funds helped me reach financial independence. Now, over to the reader.
We have all received the advice – “Do not combine insurance and investment”. Typically, we are sold an endowment or ULIP policy before we gain proper knowledge on investment avenues such as mutual funds or equity. Even when we have some idea that we should not mix insurance with investment, we fall prey to sales talks from RMs or Insurance agents. Here is a real-life example of a mistake I made and my learnings from this mistake being invested in over 20+ years.
Policy details
- Policy Name LIC New Jeevan Shree (Plan 151)
- Policy Start Date Oct 2002 for 25 Years policy with 12 years premium payment
- Key Features: Guaranteed Rs 70 for every thousand Sum Assured for each year of Policy.
- Loyalty Bonus: declared at the end of the policy
- Actual: Sum Assured – 35,00,000
- Guaranteed Addition = 61,25,000 (3500 * 70 * 25)
- Loyalty Addition – 4,00,000 to 12,00,000 (Only known at the end of the policy)
- Yearly Premium Rs. 2,60,316 for 12 Years. Total: 31,23,792
- Maturity: Oct – 2027
- Current Value: Approx 50,00,000 (If the policy is closed today).
While it looks fantastic with the guaranteed addition, the major attraction to take the policy was the 1 crore maturity value. Back in 2002, it was a great target, but that is what innumeracy and our lack of imagination for future growth can do to us.
Even today, I can see agents referring to Jeevan Shree and New Jeevan Shree (popular LIC policies with relatively higher returns), which no longer exist to justify the greatness of endowment policies.
Around the 9th year, I realised the mistake, but it was too late for a course correction. Between years 10 and 12, I thought long and hard to decide whether to continue to pay the premium or make it paid up. However, the damage was already done, so I paid the premium fully to keep the policy in force.
Let’s consider an imaginary situation of not mixing insurance and investment. Suppose the premium for 35 lakh term cover in 2002 for a 26-year-old was about Rs. 5,500.
So 5500 * 25 = 137500 needs to be set aside for the yearly premium of term insurance to match the insurance coverage of the above policy.
That leaves 31,23,792 – 1,37,500 = 29,86,292 for 12 years for Investment. Let’s assume we invest this amount in mutual funds for 12 years as we paid the yearly premium of this policy.
That is approx. = 2,48,858 per year for 12 years or 20,738 per month for 12 years. Let’s round to 2,48,000 yearly and 20,500 monthly for easy calculations. I took 2 different funds available in 2002 and did a simulation as a yearly SIP and monthly SIP for 12 years. Here are the results (as of 19th Nov 2023) from a dummy portfolio from ValueResearch online.
- LIC: Rs. 50,00,000
- HDFC Flexi – YearlySIP: Rs. 4,87,03,496. XIRR: 18.3%
- HDFC Top100 YearlySIP: Rs. 4,12,29,543. XIRR: 17.2%
- HDFC Flexi – MonthlySIP: Rs. 4,16,25,186. XIRR: 17.8%
- HDFC Top100 Monthly SIP: Rs. 3,50,415,08. XIRR: 16.6%
Both funds have changed character over these years and are considered regular plans to keep things simple.
Editor’s note: Such a backtest with specific funds has built-in biases and assumptions, some of which may not be practical. Nonetheless, the message the reader wishes to convey is unchanged and clear.
It is obvious mutual funds are a clear winner by miles, which is why they say do not combine insurance and investment.
With an assumption of 4,00,000 loyalty addition, XIRR as of maturity date is 6.05. While it is impossible to predict the market, we will have to wait and see the mutual fund returns on maturity.
Let’s see some Pros and Cons of this Policy.
- Discipline: The only advantage I see is the discipline it brings into paying the yearly premium for a careless investor.
- Lock In: Money invested is truly locked in until you get the amount at maturity. In Mutual funds, we might sell, withdraw partially, switch funds, etc. Even then, a disciplined investor should do well in mutual funds.
- Taxation: The above policy is tax-exempt as it was taken in 2002. However, even with LTCG, a mutual fund does just fine due to the higher returns
- Low Returns: Returns are low and do not beat inflation. While large future value looks attractive in the prospect document, in the real world, it is useless. Neither Insurance is adequate nor the returns.
- Liquidity: We can liquidate or withdraw partially from the mutual funds if there is a short-term need. Partial withdrawal could be a terrible step in an endowment policy, and the process is cumbersome.
The lessons will remain the same even if you divide all numbers by 10 (. Do not mix insurance with Investments.
In Summary, I learned the hard way that we should not combine Insurance and investment. Taking adequate Term and health coverage and investing enough for goals will be a better approach for anyone. Happy Investing.
Reader stories published earlier:
As regular readers may know, we publish a personal financial audit each December – this is the 2022 edition: Portfolio Audit 2022: The Annual Review of My Goal-based Investments. We asked regular readers to share how they review their investments and track financial goals.
These published audits have had a compounding effect on readers. If you would like to contribute to the DIY community in this manner, send your audits to freefincal AT Gmail. They could be published anonymously if you so desire.
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Dr. M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter, Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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