[Editor’s note: This article represents the writer’s personal views and does not represent Planner Bee’s opinion, and should not be considered as financial advice.]
A friend who hasn’t contacted you in a long while asks you out for coffee, and predictably, they want to sell you some insurance. It’s to help you save, they might say, as they ask which bank you put your money in and how you can get better returns compared to the bank,
Your friend might really want to “help you” (and the lucrative commissions they get by selling such plans doesn’t hurt), but here’s why you shouldn’t commit to a long-term insurance savings product, also known as an endowment plan.
What are such plans?
Endowment products have many different names, from “retirement plans” to “education plans”, and have different tenures ranging from 5 to 25 years, or even up till age 80. Most require a regular monthly or annual premium, and there would be a payout when the plan matures.
The benefit illustrations typically display two columns: projected values at 3.25% and 4.75% p.a.
Let’s look at a few reasons why I think it’s a bad idea for most working adults:
High upfront commissions
How much of your first-year savings do you think go to your agent as commission?
Whatever number you can think of is certainly lower than the reality. For plans that are some 20 years or longer, as much as ALL your first-year “savings” are distributed to your agent, your agent’s manager, and sometimes your agent’s manager’s manager as commissions and bonuses.
Over the next couple of years, as much as another full year of premiums further taken as commissions, which means you are incurring much as two years’ worth of premiums as commission. That’s a lot to pay to “support your friend”.
The underlying portfolio is too conservative
The obscene amount of commissions aside, another reason why such plans are generally a bad idea is because the underlying assets are overly risk-averse and conservative, especially when the plan is for over 20 years.
These plans are vested in the insurer’s Participating Fund which typically contain 30% in equities and 70% in safer assets like fixed income instruments and other lower-risk assets. For a long term horizon, this is arguably too conservative which greatly limits your returns.
The Rule of 100
The Rule of 100 suggests that you subtract your age from 100 and that is the percentage exposure you should have to riskier assets like equities. 30 this year? This rule states that you should place 70% of your investible savings into equities. More risk-seeking individuals can use the number 120, while more risk-averse people can tweak the number to 80.
Equities may be risky if you have a short timeframe, but it is the better choice if you have a long time horizon to ride out the volatility.
Poor returns even at the low risk level
Even if you are indeed fearful of losses and thus want a low-risk product to save in, you must recognise that there is still risk when you commit to a plan like. Given the availability and ease of different investment tools we have in today’s world, you can easily set up an investment portfolio with 30% equity exposure with the rest in safer asset classes through robo advisers, unit trusts, and/or ETFs.
In the long run, the returns would be superior to buying a savings plan because you get to save on 2 years of savings, a staggering amount especially when compounded over the years.
The risk level is also comparable since the underlying asset allocation is similar.
Poor liquidity, and non-payment of premiums lead to capital loss
Should your financial situation change and you cannot afford to set money aside, your plan runs the risk of lapsing if premiums are not paid. Such plans also have poor liquidity, and most plans will not allow you to make withdrawals without incurring an interest rate on the amount withdrawn.
Other investments tend to allow you to sell off your holdings at the prevailing market value for cashflow.
If you somehow still want a savings plan, make sure to compare across different providers. The difference in returns and features can be very different. For something that stretches a couple of decades, you should probably do some research before committing.
This article was first published on Sethisfy, our finance blogger friend! These are the writer’s personal views and do not represent Planner Bee’s opinion, and should not be considered as financial advice.