Knowing what "buy term, invest the difference" means | Insurance

By ZigfredDiaz
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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.

To drive home the point, let me give you an actual situation. Sometime last week, my mother asked me if she should continue paying an insurance product she got for my sister. The total price for it was about P 400,000.00 (Philippine Peso). Half of it is already been paid leaving a balance of P200,000.00.

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.

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.

If you add the total money that my sister will be receiving, she will get a total of P1,520,000.00 at age 65, that is if she opts to get the lump sum at age 65, plus she is insured for two million pesos.

Under the "buy term invest the difference scheme" since she has already paid partially for the insurance product she will convert what she has already paid into "term insurance" (That is if the insurance company allows it) This is usually good for only 20 years. The P 200,000.00 will then be invested at a vehicle of investment that gives about 10 %+ return per annum. The profits derived from the ivnestment will also be re-invested in order to take full advantage of compounded interest. If she faithfully does this until she reaches the age of 65, she will get an estiamted P17,639,497.05.

Now do you see the difference? What is P 1,500,000.00 vs. P 17,000,000.00+. Even if you add the insurance coverage that is only a mere P 3,500,000.00, it still cannot compare to the 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.

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.

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

About the Author

Zigfred Diaz is Vice president for operations for a group of family owned corporations. He is also a Financial & Real estate broker, lawyer, law professor & writer. He regularly blogs about several topics including finances and investment strategies Visit his blog today to learn more !!!

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