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You have probably heard of the saying “Buy term, invest the difference” when getting insurance and putting your money in investments. But do we really comprehend what it actually means? What could be the reason why majority of financial planners strongly recommend that you should “buy term and invest the difference” ? On the other hand why is your insurance agent forcing you to buy his or her recommended product?

Most whole life insurance products in the market today are considered rip offs. In fact, these kinds of products have already been considered obsolete in the United States. (Term insurance refers to insurance with life coverage only, whole life on the other hand refers to term policy with an investment component. These kinds of products are usually presented as helping you “force” to save for retirement. The problem with the investment part is that they do not usually give a good rate of return) Sadly these type of products are still sold in the Philippines and people still buy them because of lack of financial literacy.

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.

I asked her what the benefits of the insurance product were. She said that after 20 years, my sister who is still 18 years old will receive P 40,000.00 per year until she reaches the age of 65. At the age of 65 she can choose to receive P400,000.00 lump sum. If she chooses not to receive the P 400,000.00 lump sum, she can choose to continue receiving P 40,000.00 for the rest of her life. Plus she is also insured for two million pesos for the rest of her life.

To determine whether she should pay the remaining balance of P200,000.00, the benefits of the insurance product must be pittied against the benefits of the “Buy term, invest the difference” strategy.

Under the insurance scheme, the total benefits my sister will be receiving is as follows; she will get a total of P1,520,000.00 at age 65. Plus she is insured for P2,000,000.00 giving total benefits of P 3,520,000.00.

On the other hand the benefits of the “buy term invest the difference scheme” is as follows: The P 200,000.00 will be invested at a vehicle of investment that gives about 10 % return per annum. She will then re-invest the profits made through the investment in order to take full advantage of compounded interest. If she does this consistently she will get around P17,639,497.05 when she reaches the age of 65. As for the payment she already made for the insurance proudct, she will just ask the insurance company to convert what she has already paid into “term insurance.” This is usually good for only 20 years. (That is if her insurance company allows it)

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 !!!