If you consider insurance an investment, you're not alone. We live in a world where every adult can swear to have received a "cold call" from an insurance agent at one point in their life or bombarded relative/family friend who is an insurance agent. This is a characteristic side-effect of the competition in the insurance business, though there is nothing amiss with this. But in such a world it is inevitable to have some common misconceptions about insurance, for instance it being widely considered a standard instrument of investment.
There is a fundamental conflict in the definitions of investment and insurance. While an investment can be termed as a risk taken in the present in hope of future returns, an insurance intrinsically aims at de-risking the future. The insurance sellers over the years have figured that disguising insurance as an opportunity to make money, strikes a chord with the money mindedness of the contemporary generation.
To the fortune of these salesmen, there exists a plenty of superficial similarities between insurance and investment, and this is what causes the confusion. In broad terms both include offering money to a financial service provider in return for a future advantage but the similarity ends right there.
Let's break things down logically, a very radical look at what insurance is and compare it to investment. The goal of insurance is to provide a cover for the financial aspect of risk. One of
the best ways to know whether something can be termed an investment is to evaluate it on the lines of a standard financial instrument.
- Liquidity: Investments should ideally be liquid. If you are investing your personal money you want to be able to get your hands on it when you want. Whereas when you buy insurance, your investment is locked in for long periods of time. An instrument that is offering a very moderate return on decades-long lock-in periods is financially absurd.
- Transparency: Transparency should be counted under one of the very fundamental rights of an investor. The insurance industry fails to make the grade with measures. There can be no valid reason to justify why an investor should have less knowledge about what is being done to your money.
- Cost: Compared to stock brokers and what agents selling mutual funds get, the cut received by insurance agents are an outrage. Their commissions are huge, with a market standard of around 25%-30% of first year premiums, 7.5% in the second and 5% from the third year onward. For a financial instrument that is supposed to provide returns on an investment this is a ridiculous reality.
You need to have life tube for safety purpose while going for a river rafting, but don't expect to reach the destination with it. We have to remember that at its core, insurance is risk management and plays specific role in our personal finance. Logical only Term Insurance can be considered as life insurance, because only in that case are you are insuring against a risk that is insurable. Keep this in mind and you'll make much better financial decisions. In conclusion, as smart investors you need to look through the veils of advertisement, rip through the repackaging and scrutinise every "investment opportunity" through sticking to basics.