Knowing what "buy term, invest the difference" means

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.

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.

To evaluate whether or not she should continue paying the P200,000.00 we will evaluate the benefits of the insurance product versus the "Buy term, invest the difference" option.

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.

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

You might ask what about insurance protection? Take note that pure term insurance is very cheap. She can just buy term insurance and renew it every 20 years.

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 !!!

Article Source: http://www.a1-articledirectory.com

Do you want to know more about investments, finances, and money management ? Zigfred Diaz regular blogs about these topics including investment strategies Visit his blog today to learn more !!!

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