A lot is heard and read about surrender of endowment plans in the media. No doubt term cover is one of the cheapest ways to protect the family for income replacement, but that is not the only thing that protects the family from practical situations.
There is no doubt that investing in equity and mutual funds do give better returns, which is the basis on which the CFPs are advocating surrender of Endowment plans. And it is one of the easiest ways for the CFP to impress the client by comparing higher returns through equity based investment with the returns of endowment plans.
While endowment plans do not give better returns compared to mutual funds, what is lacking in the advice is the practical aspect of living.
We prepare a comprehensive financial plan or for that matter even a goal based financial plan and advise the client that a systematic investment in the chosen mutual fund will meet the goal which will beat inflation. But, can we look at this more practically?
As human beings we are disciplined only when we are compelled to. When there is no compulsion the discipline tends to go awry. This is proved by the fact that approximately only 40% of the persons who have started the SIPs (Systematic Investment Plans) with mutual funds are actually staying till the end of the term. This means, 6 out of 10 discontinue in between.
When this concern was discussed with some of the CFPs, the answer was “it is up to the investor to stay the course if they want to meet the goal”. Agreed that it is the individual’s necessity so he better stick to his commitment. But as professionals, is it not our duty to also look into it more practically?
Life is not as smooth as it appears on paper. In spite of all the planning, life can throw surprises and unforeseen emergencies. So in such circumstances the easiest fall back is on funds that are easily accessible - mutual funds. And what goes for a toss is the goal for which the mutual fund was meant for.
Imagine a situation where a person had planned his/her child’s professional education or daughter’s marriage. If he/she had invested only in mutual funds and taken a huge term cover, and unfortunately a situation similar to the 2008 global meltdown arises. Where does the person stand? Can the person postpone the child’s education because the Planner failed to protect them in such situation?
Dear CFPs, please note that it is very easy to advise surrender of policies, but wake up to facts of life and reality. Working on excel sheets no doubt gives impressive output, but let it also work in all circumstances.
To substantiate my view, I have taken an example of a 35 year old person who has taken LIC’s endowment plan for 21 years in order to accumulate some money for his child’s overseas education who is one year old. Now let us see, how this endowment plan performs..
I have considered two scenarios i.e., with tax benefit (30% slab) and without tax benefit (under section 80C) after setting aside the term cover part of the premium…
Investing in a term plan vis-à-vis an endowment plan
Plan
|
21 years
| ||
In the last column, we see that in spite of including the term premium and by also not considering any tax benefit the internal rate of return (IRR) works out to 6.30%, while the first two columns show clearly the IRRs with and without considering the tax benefit, which are 10.62% and 7.30% respectively. These are conservative returns, and the capital is also protected. Thus an endowment plan can be safely considered as debt component in the asset allocation, instead of asking the client to surrender.
Yes, one can include existing insurance plans based on its merits and then suggest improvements and additions while drawing up a financial plan.
This will indeed help the client overcome an adverse situation by protecting the extent of the maturity amounts from endowment plans which are not directly impacted by the market fluctuations.
vinay mohanty
Fantastic weblog ! This blog have information about Systematic Investment Plans. Thanks for this post and i will share this with my friends.
ReplyDelete