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Sunday, 12 August 2018

Do we need Insurance?

Insurance is a contract between two parties where one pays the premium to other to cover a specific potential financial loss. It is not an investment at all. It is just like the foundation of a portfolio. Any good portfolio is incomplete without a cover. As we can’t think a multi-storied building with a deep strong foundation we should not even start thinking of investing for future without insurance. There is an old say i.e. “safety first” so we should think about Insurance first then Investment.

Most of the time people get confused with Investment and Investment. Most people do not understand that the basic Logic of Life Insurance is to provide security to your Family from an unfortunate event. Insurance should be bought for protecting your financial future and for securing your financial future. It should not be mixed with Investment which should be done for creating wealth for the future. Insurance is an expense or cost to protect our financial future from an unfortunate event. It is always better to avoid mixing your Insurance with Investments.

In India if you look around then you can easily find that maximum number of people pays their premium between December and March just before the financial year end. What does it mean? It means. People buy Life Insurance for the purpose of saving tax which is again wrong thing to do. Just because buying Life Insurance lowers your tax burden it is understood by most people that it is the best form of Investment. These are the money back policies which can give 5 to 6% per year. They offer very small cover too, which will not be sufficient for dependents after her or him.

So what should be done? When it is insurance then we should only have the pure term insurance policy. Here the premium is very less compare to money back policies form same amount of coverage. Rest all the saving should be invested in high yielding instrument like equity or equity related assets. In any time period this combination can give better return than any money back policies. Let me explain this with an example.

Suppose there are two friend Ravi and Shashi. Both are 25 year old. They have decided to save ₹30000 per year for 30 years. Ravi has decided to invest this surplus in a FD which can give max 8% return(on higher side). It will also give the coverage of ₹600000 to ₹700000. On the other hand Shashi buys a term plan with ₹6000 with a cover of ₹2500000. And remaining ₹24000 in Equity mutual fund. Equity has a historic CARG is 17%. But for my calculation I have taken on 13% CAGR return.

Now refer the above table. At any point of time Shashi will get better corpus. One thing I like to mention that equity return will not be so steady. It is going to be volatile but in long run it will beat any fixed return asset class.

If both friends increase the investment by 5% each year then the return will be like this.

You can download the excel file for you reference from here.

Hope this will help……

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