17 Nov 2008 | Comments | insurance | Comments feed

Buy term and invest the difference

This insurance buying “philosophy” has been preached many many times by some of the top personal finance gurus and authors, especially those from foreign country. What I am talking about is the technique of buy term and invest the difference (BTID).

I haven’t written anything about it, yet. Mooi (a blog reader and a regular forum contributor) actually asked this question in the forum. There is a very interesting discussion. You should really take a look at the forum post about what we’ve discussed so far. In this post, I will share my view about the reality and practical part of making use of this well-known strategy.

Story about Jack and Marry

Jack and Marry are husband and wife. They just got married and felt that they should insure themselves with proper life insurance policies.

Jack told the agent,”I want to pay the lowest premium to get the highest coverage.”

Agent replied,”You should buy a term policy.”

Marry disagreed,”I want something that gives return. I don’t want to pay premium and get back nothing at the end!”

Agent said,”Whole life assurance plan provides some decent saving. So Jack, whole life or term?”

This is a usual dilemma. I won’t say who’s right or wrong. They just have different opinion.

What’s Buy Term and Invest The Difference

Let’s say you can afford to buy a whole life participating policy which requires RM5000 annual premium. In order to get better value out of your money, you can instead buy a term insurance with exactly the same sum assured, and use the extra money to invest.

In other words. You can use RM2000 to buy only term insurance, not whole life plan. And the other RM3000 can be invested to get better return.

This strategy is based on the believe that you can invest better on your own instead of relying on the insurance company to give you mediocre cash bonus return.

BTID emphasize on paying the least amount of insurance premium possible, and use the monetary difference to save and invest. If you are paying too much for insurance, there is not much left for investment.

In long term, say 20-30 years later, you might have invested enough and become wealthy. Then insurance is not an issue anymore because you are already rich! You don’t really need insurance when you are rich right? This is the concept behind BTID.

I don’t agree with this statement completely because I know the richer a person gets, the more insurance he buys. This is a fact, not an opinion. I will share more about this other time.

How do you do it in Malaysia?

The financial industry in Malaysia is still many years behind those developed nations.

Unlike in the developed nations such as US and UK, the term insurance in Malaysia is not really cheap. I checked with some online insurance websites, the term insurance selling in the US and UK is much cheaper. The premium is 20-30% cheaper than a term insurance available to Malaysian.

However, there are some other options to choose from, such as group term insurance, probably offered by unit trust companies, or through some association of private companies which is exclusively for employees and members only. And there are also some disadvantage of insuring yourself under a group term insurance. Some plans premium can be revised. Some may require good health at renewal. And these kind of plans are not easily accessible.

To buy cheap term insurance online, we would still have to wait. I don’t know how long it’s going to take. Until the day you want to buy insurance spontaneously (without agent sale-pitching you), probably insurance companies will cut the premium because they can reduce the commission paid to insurance agents.

When you are able to get sufficient coverage by paying the least amount of premium, the extra money you saved should be invested wisely.

Term insurance or Investment-linked?

Based on the Great Eastern Gelsis quotation software version 5.05, a male life assured aged 30, buying an insurance plan with sum assured of RM250k (Death and Total Permanent Disability benefit only), would need to pay

1. Term Assurance (30 years)
- annual premium - RM1617.50
- cash value after 30 years - NIL
- total premium paid - RM48,525 in  30 years

1. Investment-linked Policy - Greatlife Portfolio
- annual premium - RM1200
- cash value after 30 years - range from zero to RM20k (very much depends on investment return)
- total premium paid - RM36,000 in 30 years

In my opinion, there are no such “cheap” term insurance in Malaysia. The best term insurance you can buy is to package the investment-linked policy in such a way that it gives you maximum coverage on the lowest premium paid.

Yes, it can be done. Of course there is some risks to take on buying an ILP. But it can be overcome by proper strategy, which I shared previously how to avoid investment-linked policy from being lapse.

Pros and Cons of buying term and investing the difference

Pros:
1. When you are able to save insurance premium, you shall have more money to invest

2. You will have more control of your investment.

Cons:

1. It is almost impossible to get total coverage.
Let’s say you earn RM50,000 a year. 20 years down the road, you will be able to earn at least a million ringgit! It makes sense to buy a million ringgit policy now! The premium is RM6470 (30 years old, term 30 years). Can you afford it? If yes, would you buy it?
In practical, some other very useful rider can be added to meet the shortfall, such as the investment-replacement feature and the income-replacement rider. It is not so simple of just buying a term policy. You should ask a trustworthy agent to plan for you.

2. Some people are not disciplined.
Instead of buying term and investing the difference, some people spend the difference!

How about Jack and Marry?

I would say that different plan suits different people with different values.

Jack learns a lot about investment and he can pretty much handle his investment portfolio well. Then for Jack, to buy term and invest the difference totally make the best sense!

But Marry don’t like about investment. She fears losing money. She even trembles when people talk about share trading. She thinks that it is gambling. Furthermore, she can’t see the “money” sitting in the bank because she would most likely spend it. In this case, locking her money in an insurance plan is really beneficial to her.

How about you? Do you think buying term and investing the difference is your cup of tea?

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