What Does It Mean To Buy Term, Invest The Difference

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 financial planners would tell us to stay away from whole life insurance products as they are considered rip offs. These kinds of products are not so popular anymore in the United States. In order to fully understand “whole life” versus “term” they are differentiated as follows: Term insurance refers to life coverage only while “whole life” refers to term policy with an investment scheme. Insurance agents usually present whole life insurance as something that will help you save for your retirement. Forcing you to save is probably something that is good for you, however the bad thing about this is that the returns for the investment in whole life insurance is very low. It is a pity that these type of products are still sold in the Philippines. Sadly, people still buy them because of inadequacy of financial knowledge.

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.

The total money that my sister will be receiving under the insurance scheme is around P3,520,000.00. This is derived from the P 40,000.00 she will receive per month until she reaches 65. Add to this the P 400,000.00 she will receive lump sum during that age. We should also take into consideration that she is insured for P2,000,000.00 hence giving us total benefits of around P 3,520,000.00

On the other hand, if we follow the buy term invest the difference scheme, if her insurance company will allow her, she will convert what she has already paid into “term insurance” which usually runs for only 20 years and then invest the P 200,000.00. If she will invest the P 200,000.00 at a vehicle of investment that gives about 10 % return per annum and also re-invest the returns of the investment taking full advantage of compounded interest at age 65 she will get a whooping P 17,639,497.05.

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.

Buy term invest the difference? It certainly does make sense!!!

Want to know more about investment strategies ? Visit the blog of Zigfred Diaz where he writes about several interesting topics such as investments, money management, business, making money online and Stock market investing