Investment-Linked Products: Why you should NEVER buy them…EVER.

You surely must have come across them. Have you ever been approached by a pleasant-looking gentleman or lady at the MRT station or bus interchange, with them clutching a little clipboard? They stick their hand out right in front of your face, smile still unwavering. They raise their voice a little to say “Sir / Madam, do you have a minute? Will not last long, I promise”.

This one day you decide to be kind. You smile back and say “Yes.”

They point you to some booth where there is another person there with a larger clipboard this time. They ask you what do you do for a living, how much you earn a month, and the golden question:

“How do you save?”

Now, don’t be mistaken, they do not really care about how much you save. They want to know where you put your hard-earned money. Many Singaporeans will reply that they will save in a savings account. Bingo. Watch their eyes lighten up as they now see you as a walking piggy bank.

They change shift. They start complaining about how ridiculous the interest rates in Singapore savings account are. They aren’t wrong there, so you nod along. They spring up to say that they have something better. They push several brochures into your face, and start mouthing off some numbers that sound attractive. You still aren’t fully convinced yet. So they pull out their trump card. They generate this number sheet which supposedly shows you the potential of your money.

Number Table.png

~Photo credit: SG Budget Babe’s post dated 31 October 2016

So they tell you stuff like this. You put in $1,800 a year, or only a measly $150 a month. Then they tell you, since your bank account is only earning you 0.05% interest, you gain an almost negligible amount of interest. So at the end of 40 years, you will accumulate $72,000. And then they tell you this:

“If you put that money with us, assuming 8% year-on-year interest, you will get $176,561!”

Oh my gosh, you think. Look at that number. So if I put a minimal amount of money with them, I will get $100,000 for free? SIGN ME UP.

STOP RIGHT THERE.

What’s wrong, you say? For starters, there are three extremely important disadvantages.

 

1.     There is no guarantee on the returns

Okay the first is a no-brainer. Much like any other investment in the market, there will always be a risk. This is because these insurance companies will take your monthly premiums, which you have paid to them, and invest it in certain mutual funds. They are, in essence, investing for you.

The earlier figure quoted about $176,561 is premised on the highest quoted interest rate of 8%. If you look at the same picture, and note the column on its immediate left. It quotes the average interest gain of 4%. After 40 years, you will only get $63,792.

Do you remember what the figure was if you saved $150 a month for 40 years, in your Singapore savings account? It is $72,000.

That’s right. This means that based on an average performance of your investment-linked policy, you actually LOSE close to $10,000.

Let me put it another way, the average performance of your investment-linked policy is WORSE than your savings account which only has a 0.05% annual interest yield.

But wait. What if my investment-linked policy does better than the average? Well, there is of course that possibility. Much like gambling, there is always a chance of winning the pot. But if you stand to make a loss on your capital at least half the time, then what’s the point of risking your hard-earned money?

 

2.     D stands for deductions – that thing that EATS away at your money

You might ask at this point in time, how is it possible for ILP returns to be, on average, worse than a Singapore savings account? Simple, you are paying the insurance company for the work they are doing for you. That lovely person who put his or her hand out to stop you at the bus interchange, and that other person who kept throwing numbers at you at the little booth? And those people who work behind the scenes to channel your little sum of $150 to click on the mouse to buy those mutual fund units for you? They do not work for free. They need to be paid as well.

How much are you paying them exactly? Do you see the figure immediately to the right of $176,561, under the column “Deductions”? Yes, you will have paid $327,045 over 40 years for investing your measly $150 a month. Let’s be clear, deductions will be defined in each and every insurance policy in a manner similar to the following:

Deductions.png

~Photo credit: SG Budget Babe’s post dated 31 October 2016

The essential thing to note is the first sentence: “[t]he deductions relate to all charges taken out from your policy.”

So let’s say your policy has done extraordinarily (maybe unbelievably) well, and performed at the 8% projected yield. At the end of 40 years, you bag home $176,561. In comparison, your insurance company has made $327,045. That is 85% more than what you have earned.

Also, bear in mind the amount of deductions do not rise or fall in accordance with how well your policy performed. If your policy performed at the average of 4% yield, the amount of deductions at the end of 40 years still remain at $327,045! Compared to the $63,792 you bring home, the insurance company earns 400% more than what you have taken home.

Let’s compare this to a base sample. Imagine if you have your own portfolio which yields 8% on your own. I explained in an earlier post that you can do this by reading up and buying some REITs in the market. How much will you earn at the end of 40 years if your interest compounded at 8% every year with a monthly contribution of $150?

You will earn $542,710.01.

Note that the insurance agents ALWAYS compare with what savings account earn? Yes, because they have a point in saying that savings accounts do not make money, and actually lose money against the annual rate of inflation. But what they never tell you is that if you invest on your own, you earn WAY MUCH MORE!

 

An insurance agent justified their fees in the following manner:

“[B]asically you still need insurance agents and financial planners to advise you on how the insurance product works and whether they are suitable for you or not. There is no way to know all the nuances and details from the website without someone explaining in details what does each feature entails. Furthermore, the way an applicant declared his health status is also important and can affect his insurance application or even coverage. So moving forward, insurance agents and financial planners would still have a role in aiding consumers and technology can never replace this human touch.”

~Quote credit: SGWealthBuilder’s post dated May 5, 2015

Essentially, the only justification is this “human touch” element. He details this by stating that insurance agents are there to explain how the policy works. Additionally, he justifies by stating that they are there to assist them on the declaration of their health status.

But this is insanity to me. Why must I pay some people over $300,000.00 to do something which I can do myself? Why must I pay them almost 75% of my potential compounded earnings? It is an absurd figure to me on all accounts.

So, do the insurance companies deserve to earn so much from your tiny contribution each month? You tell me.

 

3.     Any insurance coverage you use (or don’t even use) EATS away at your money as well.

After realising that your money is firstly being eaten by average interest rates (which they skim through during the sale of their product) AND the hefty amount of deductions, this is the icing on top of the ridiculous cake. The whole point of an investment-linked policy, as hawked by these agents, is that you have the flexibility to adjust your insurance coverage in tandem with your investment needs.

How does this work?

For a traditional term insurance, for example life insurance, all of your monthly or yearly premiums are given to the insurance company for them to insure your life. Much like ILPs, they use the money to invest it so that any returns they make will become their profit. But you, or more accurately your beneficiaries, are guaranteed the big lump sum should the unfortunate event of death occur.

Investment-linked policies work in a slightly different manner. Earlier we mentioned how your monthly premiums will be used to buy units in a mutual fund they have selected under the policy. Mind you that this is after they have made their ridiculous deductions. Now this is the absolute nuts. Following the purchase, they will sell some of your existing units to pay for your insurance premiums.

What does this mean? For starters, you will be charged for your investments and for your insurance. Not only are you getting charged in the form of deductions from them managing your portfolio, you are also paying for your insurance as well. Undoubtedly, it will impact your final figure when you finish your 40-year run with the insurance company. That $176,000 promised in the beginning? It will never happen.

Secondly, insurance premiums are never static. Everyone, and especially the insurance companies, know that as you grow older, the likelihood of you dying or falling really ill increases exponentially. To balance out this risk, they charge you more for your insurance premiums. Therefore, it is much cheaper to insure a 12-year old boy than a 75-year old man. The catch with ILPs is that they promised that you only need to put in a tiny sum per month. But there will come a point in time when that tiny sum cannot even cover the insurance premium that they will charge you. The following is an extract from a government website:

MoneySense.PNG

Let’s break down what they are saying:

  • Firstly, even if you maintain the same ratio between insurance coverage and investment needs over the years, your insurance premium increases. This is due to the fact that you are getting older, as explained above.
  • Secondly, because you are paying more for your insurance, you will receive less at the end of the policy, as explained above as well.
  • Thirdly, there may come a point in time when the value of what you put in is simply insufficient to pay for your insurance, let alone for your investment needs.
  • Fourthly (and this is the kicker), your insurance premiums are not just affected by your age. As mentioned in the extract, they may also increase “if there has been a general and sustained worsening of claim experience”. In this case, the term “general” refers to the “entire class of policy”. This means that if you and a thousand other people have purchased the same policy, so long as any one of them make a claim on their insurance, your own insurance premium will increase correspondingly as well.

 

 

The final lowdown

There are much more things to cover in this topic, such as the fact that you may even be penalised if you withdrew before the policy matured, thereby eating even more into your hard-earned money. As with many other things in life, the devil is in the details. And there are many “little demons” lurking in the terms and conditions of such investment-linked policies which pilfer your hard-earned money.

Will I ever invest in such investment-linked policies? No way in hell. I’d much rather invest the money on my own, and keep my own $300,000.00 in fees.

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