You will fall for the death traps aka insurance
By now my take on insurance policies is quite clear. I have the data to prove or disprove, whichever way you want to look at it. So here am once again writing a small nugget on my experience with one of the LIC agents. The agent is a far relative of mine(needless to say :) ). He called me one fine day and said, “Good news for all working people, especially during trying times, LIC has come up with a guaranteed pension plan”. He sent me a nice pic of the illustration below. Like always, every pension comes like an exotic package with great illustrations and emotional statements. It's hard to resist and NOT buy when they say, it protects your family. What they actually meant is to protect themself( by way of FAT commissions).
Here is the pic, ensuing story, and my take on this entire episode!
He was stressing that the rate chart is far higher than the inflation. (See the red circle in the above illustration) .More often than not, we fall into such mathematical gimmicks because we have not understood the basic math and the time value of money during our school days. So I cannot blame anyone but myself if I buy them at the face value. Simply put, 100/- today is not worth 100/- after 5 years. Its value would have decreased. Yes, time-value is common sense but not so much, for us.
Now take the case for Deferment period = 5 Years. Purchase plan = 10 lakhs ( that means its a 1-time premium ), deferment period = 5 years ( So 5 years you will get nothing but a cursory phone call from your agent ), Annuity = 91800/- ( So the fun begins at 6th year when you get 91800/- every year thereon) and you feel you made 9.18% return on your 10 lakh investment(See the rate chart above). Am sure, the agent would have cemented this concept to an extent that you will not believe what I am gonna say next.
9.18% was true if the 10 lakh(you invested “today”)started to earn the return for you from Day 0. But in this case, you have to wait for 5 years. So by the 6th year, the value of 10 lakh would have gone down, and ideally, your annuity should be calculated against the new value at the 6th year, 7th year, and so on. Since our system 2 thinking brain understands complexity( is it really ?), it waits for system 1 / lazy brain to instruct system 2 to think and let him know. But guess what, our evolutionary design is such that, system 1 always takes over as long as its a not a near-death situation in which case it will rely on System 2 to think and respond. Because of this trick in our own minds, we believe that we made a 9.18% return.
Here is a quick look at our brain structure which is divided into 1 and 2
If you have time by your side, you can read this book and understand a bit more about our evolutions and how our behaviour is shaped in the history of mankind.
But for now, it's sufficient to say, the inherent nature of our brain leads us to make wrong decisions perhaps what appears to be a good decision.
Back to the insurance story — If you really need to calculate the actual return, Excel provides a simple but effective function called IRR ( Internal rate of return ) which takes into account the time value of the money and spits out the rate you get for your investment. And all that it took me to do this was 30 seconds. I knew that the agent was simply lying because the commission for this policy is as high as 20% of the premium. I am just guessing here but could be higher. So you just made him rich by way of not knowing basic maths!
Here are the calculation and the return based on the assumption that you paid the premium when you were 40 years and the deferred annuity is 5 years. So at 46, you start getting the annuity/pension. Assuming you live for another 30 years ( by the by, rate of return do not vary much just because you live longer :) ) .Guess what, the return you get is a mere 5%. Remember, on the annuity, you will have to pay the tax as well! How cruel it can get!
What I just told is a real-life scenario happening with many of us and millions of people are duped into buying exotic insurance and unit-link plans. As long as the fat commission continues for insurance agents, as long as insurance companies trap you in these death traps ( paradoxical as they are supposed to be life covers and not death covers!), you will never be able to cover the risk of your life adequately nor you can make meaningful returns, period.
The best and simple way is to
- SIP in your stocks which you have researched thoroughly
- SIP in diversified mutual funds if you do not have time to analyze individual stocks
- Give a time frame of a minimum of 10 years and perhaps 20 years if you can and just enjoy the bounty of the sheer growth of equity!
4. Well if you have “enough cash”(note the emphasis on cash), invest in land as Mark Twain famously said
5. Invest in yourself — Do what makes you happy and perhaps the simple steps I described above would open the door towards that road...