Think about how a pilot plans for an emergency landing. A farmer makes all plans for a floor or a drought. A bank also makes provisions for bad debts. This list can go on and on.
Risk is an inevitable part of everyone’s lives. Thus, our objective also needs to shift from loss aversion to positioning ourselves better to manage risks. We also need to plan for our retirement or uncertainties in life.
Every generation has a different lifestyle. Naturally, they then also prefer different investment styles. However, some focus on wealth creation, while others focus more on building their children’s future. Yet another set of investors focus more on retirement planning. Thus, every individual needs to plan according to his or her needs and goals.
An investment is something in which you put money, and you then expect it to grow over time. There are many financial investments available in the market, such as debt instruments, stocks, certificates of deposits, mutual funds, commercial papers, etc; that help to multiply your money.
Investors also buy insurance policies to meet their financial goals. Often, people buy an insurance product with investment elements in them also; such as a ULIP. This helps to take care of both insurance and investment.
However, investment and insurance products both serve very different purposes. An insurance plan protects your family against any unforeseen eventuality. On the other hand, an investment product such as a mutual fund helps to create wealth for you to meet your goals.
Mixing your investment and insurance needs results in a dual loss: inadequate life insurance and lower returns on investments. By doing this, we are challenging the very purpose of both life insurance, which offers a proper cover; and an investment scheme that offers attractive returns.
Mixing the two is a serious problem that needs to be looked at. Or else you would end up with insufficient life cover and poor returns. And while this does not make sense now, it will after some time.
Is life insurance a good investment?
Let us get the basics correct. Life insurance is not an investment. No investment in insurance will give returns on the amount that you have invested.
Life insurance is something that your nominee will reap the benefits of when you die; and that is the irony. This brings us to the question; why should you buy life insurance when you are not even getting any returns!
Imagine that Mr. X is the sole bread earner for the entire family. He visits a foreign country for a business trip and gets stuck there for some time. He will have to send money for the functioning of his home, and other household activities,
What if, some unfortunate events take place, and Mr. X is never able to return home? Will the money sent by him be enough for his family to be able to live forever?
Who will pay off the loans that X would have taken? While the emotional gap is hard to fill, who would fill the financial gaps?
This brings us to a very important question. How much insurance cover is enough for an individual?
To calculate the insurance cover, follow the income multiplier of 10 as a simple thumb rule. Though this is a bit outdated, taking into consideration the economy and inflation. Additionally, this rule does not take into consideration any previous insurance policy, savings plans, or other factors. Thus, while this is a commonly followed rule, it does not take a deep dive into your family's needs.
You need to take into consideration a cushion for any debts, mortgage, future needs, education, etc.
It is also a good idea to take into account the DIME rule to calculate the human life value. DIME stands for Debt, Income, Mortgage, and Education. These things added together will give you a comprehensive number.