Buying Insurance as an Investment - A Smart Strategy or Risky Move?

Insurance is an essential part of any financial plan since it offers a defence against unanticipated events that could result in substantial losses. However, in the last few years, there has been a growing trend of people considering insurance as an investment tool. Many investors purchase insurance policies intending to use them to yield a return on investment. While it seems like an attractive option, it is crucial to understand that insurance and investment are two important financial tools that serve different purposes.

What is Life Insurance?

Life insurance policies provide protection against unexpected situations, such as the policyholder's death or disability. In addition to financial security, various types of policies allow policyholders to invest money by making regular contributions to different equity and debt fund options.

With the right life insurance policy, you can protect your family's financial future from life's uncertainties. The policy provides coverage for a large sum of money paid to your loved ones if anything happens to you. You can select the policy period, coverage amount, and payout option based on your financial needs.

There are several types of life insurance policies:

• Term life insurance

• Whole life insurance

• Endowment plans

• Unit-linked insurance plans

• Child plans

• Pension plans

Among the various types of insurance policies, term insurance is considered the most basic and economical. It enables you to choose significant life coverage for a specific duration.

The other types of insurance are investment-cum-insurance plans. Among these, Unit-linked Insurance Plans (ULIPs) allow policyholders to invest in different types of equity and debt funds while providing life coverage. A portion of the premium paid by the policyholder is used for insurance coverage, while the remaining amount is invested in various funds according to the policyholder's preferences. The investment returns are linked to the performance of the funds selected by the policyholder, and the insurance coverage provides financial protection in case of unfortunate events.

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There are several benefits to investment-cum-insurance plans:

1. Dual Benefits: These plans offer both investment and insurance benefits, allowing policyholders to fulfil their long-term financial goals while ensuring financial security for their loved ones.

2. Flexibility: Policyholders have the flexibility to choose the amount of investment and insurance coverage as per their financial goals and risk appetite. They can also switch between different funds based on their investment preferences.

3. Tax Benefits: Investment-cum-insurance plans offer tax benefits under Section 80C and Section 10(10D) of the Income Tax Act, making them an effective tax-saving tool. However, according to a proposal made in the Union Budget 2023-24, if a customer pays an annual premium of over Rs 5 lakhs for their traditional insurance policy, the income received upon maturity will be taxed.

4. Wealth Creation: These plans provide an opportunity to create wealth over the long term through investment in equity and debt funds, thereby enabling policyholders to achieve their financial goals.

5. Customised Options: Policyholders can customise their investment-cum-insurance plans based on their requirements, such as the policy term, premium payment frequency, and investment options.

6. Financial Protection: These plans provide financial protection to the policyholder's family in case of unfortunate events such as the policyholder's death, disability, or critical illness.

While investment-cum-insurance plans have several benefits, there are also some drawbacks that you should be aware of before investing:

1. High Charges: Investment-cum-insurance plans often have high charges such as premium allocation charges, fund management charges, and surrender charges. These charges can significantly reduce the returns on your investment.

2. Complex Products: These plans can be complex, and it can be challenging to understand the investment and insurance components. This can lead to confusion and make it challenging to make informed investment decisions.

3. Limited Investment Options: Investment-cum-insurance plans offer limited investment options compared to other investment options such as mutual funds, stocks, or bonds. This can limit the diversification of your portfolio and potentially reduce the returns.

4. Lower Returns: The returns on investment-cum-insurance plans can be lower than other investment options due to the high charges and limited investment options.

5. Long-term Commitment: These plans require a long-term commitment, and exiting the plan before the maturity date can result in significant penalties and surrender charges.

6. Insurance Component Maybe Insufficient: The insurance component of these plans may not provide adequate coverage for your family's financial needs. In such cases, you may need to purchase additional insurance coverage separately.

Why you should not buy insurance for an investment purpose?

Let's start by clarifying that insurance and investment are not the same things. When you invest, you expect a return on your money, but with pure term insurance, you only receive a payout if you pass away. It may seem like a bad deal, but that is the whole purpose of life insurance - to provide financial protection in the event of death.

Unfortunately, many people prefer insurance policies that offer something in return even if they do not die and therefore overlook pure term insurance policies, which are undoubtedly the most basic, cost-effective, and reliable form of life insurance.

By investing in an investment-cum-insurance plan, the policyholder ends up stuck in a long-term commitment that may neither generate attractive returns nor provide sufficient life insurance coverage. Hence, even after buying such products, policyholders have to make separate financial plans to achieve their goals and buy separate term plans to ensure their loved ones are adequately protected.

Why Equity Mutual Funds could be the right investment avenue for you?

An Equity Mutual Fund is a type of mutual fund that invests over 65% of its total assets in stocks from various sectors and companies. The fund's allocation of assets is managed by an experienced fund manager. While Equity Mutual Funds can be considered a moderate to high-risk investment, they can also offer high returns. If you choose carefully selected Equity Mutual Funds and make a long-term investment, you have the potential to achieve your long-term financial goals based on the amount you invest.

Investing in Equity Mutual Funds has various advantages and benefits, which include:

• Equity Mutual Funds provide a wide range of investment options and diversification in investment styles.

• Carefully selected and well-researched mutual funds can generate enough funds to achieve your investment goals while also beating inflation.

• Starting a mutual fund investment can be as low as Rs 500 per month through a Systematic Investment Plan (SIP).

• In case of emergencies, mutual funds can be partially or completely liquidated.

• Mutual funds provide flexibility and variety in investing, enabling you to design a financial plan that meets your specific needs.

• Diversifying the portfolio can easily reduce the risk of equity mutual funds.

• While mutual funds do not offer any tax benefits unless invested in Equity Linked Saving Schemes (ELSS), they can provide much higher returns compared to tax-saving insurance-cum-investment plans.

• Equity Mutual Funds do not provide any death benefit since they are not life insurance plans.

Why investing in equity mutual funds is a better option than investment-cum-insurance plans for your long-term financial goals?

Some thoroughly researched ULIPs might prove to be worthwhile in the long term. However, when compared to carefully selected equity mutual funds in terms of cost, flexibility, transparency, and returns, ULIPs may not be the best investment option for long-term goals such as retirement, a child's education, or a child's wedding.

Hence, it is recommended to invest in carefully selected equity mutual funds for your long-term goals rather than insurance-cum-investment plans that neither generate decent profits nor provide adequate insurance coverage. In addition to investing in equity mutual funds, it is also advisable to purchase a term plan to secure your family's financial future in your absence. A term plan offers maximum coverage at an affordable premium, unlike investment-cum-insurance plans that offer life insurance coverage of only up to 10 times the annual premium. Click here to read more about term life insurance.

KETKI JADHAV is a Content Writer at PersonalFN since August 2021. She is an MBA (Finance) and has over seven years of experience in Retail Banking. Ketki specialises in covering articles around banking, insurance, personal finance, and mutual funds and has been doing it for over three years now.