One of the most repeated lines in the media is that traditional life insurance endowment is low return and that if one wants life insurance it is better to buy term insurance and with the balance of money (saved by not buying traditional insurance) buy mutual funds. This is one of the most unscientific statements to make in the field of financial planning.

Reason 1

It is misleading the public by telling them low risk endowment and high risk mutual funds are interchangeable investment options. They are not. One of the principles of financial planning and making investment decisions is Compare like with like. You cannot compare apples with oranges. You have to compare apples with apples and oranges with oranges.

There are investors with an appetite to take risks and there are others who do not have a desire to take risks. Those do not wish to take investment risks are the vast majority. To tell such persons that mutual funds is better than traditional endowment and giving them a feeling that the risks in the two are the same, amount to a sinful practice in the market.

When the returns on a risky investment (such as mutual funds) have to be compared to the returns on a low risk investment such as traditional endowment, finance theory has a method of doing so. The method is the degree of “risk” in a risky investment is adjusted to make it comparable to lower risk investments. When the degree of risk is adjusted we get a new rate of return called the Risk Adjusted Rate of Return (RARR). The RARR can be compared to the return on the lower risk investment. Just to give you an idea of the RARR in mutual funds  (Read the Article: How Are low Risk Investments to be compare with High Risk Investments) about 55 % of all mutual funds in India earn an RARR of less than 8% p.a (Read further on mutual https://www.helpindiainsure.iistpune.in/2018/08/04/bull-run-or-bear-it-is-never-safe-to-invest-in-mutual-funds/. This means that mutual funds actually do not give higher returns. It is only the articles in the media that make it seem so.

Reason 2

Life insurance endowment is purchased for long term financial needs. Mutual funds are short term investment products. No matter what is said in the media, mutual funds, being a risky investment cannot be offered for long term needs. The investor faces more risks by holding a risky investment for a long period of time. The world is undergoing many changes at a sweeping rate. There are many changes in the product and services markets, new technologies are coming in at a fast rate, customer perceptions of products that suit them are changing by the day. In such a scenario it is difficult to predict even in the short run, forget the long term. Mutual funds invest in the shares and debt of companies which are facing technology risks, market risks, finance risks etc. What makes the mutual fund organisations to believe that they can predict these risks over a period of 10 years or more? Obviously it is not possible.

Prudent financial advice is that risky products are held for the short term, while lower risk financial products should be chosen for the long term needs.

Reason 3

A long term financial need requires an investment product that is long duration, low risk and low liquidity. Mutual funds do not meet any of these requirements. Traditional life insurance endowment does. In the language of finance this is also called Asset Liability Matching. That is, one should invest in a product that matures approximately at the time that the financial need is likely to arise. Suppose one is to retire in about 20 years from now, savings should be made in a product that will mature after 20 years. If Asset Liability Matching is not done then there are very high chances that money will not be available when required in the future period. Prudent financial planning therefore calls for prudent Asset Liability Matching. Indian investors are highly prudent. One-third of all their savings is in long term financial assets. (Read RBI data: Where Do Indians Save?)

Its Fraudulent Advice

Comparing mutual funds and traditional life insurance endowment in a simplistic manner without adjusting the risk of mutual funds, ignoring the fact that they are very liquid and without considering the duration angle, amounts to a fraudulent selling practice. When we sell financial products we must take extra care to ensure that we do not advice investors wrongly and lead them to financial disaster. You can be proud that in life insurance you do not have to make such misleading statements.

Sell Risks Not Returns