Insurance Vs Investment

Very often and more often than we think we use the two words- investment and insurance- as if they mean the same thing. Yes indeed they do mean the same thing in one sense. Both require us to part with some money to be got back with more or less certainty after some time. But that is all that is common between the two, not a bit more.

Investment is parting with money with a desire to get it back after some time, mostly in a bigger quantity amount. But our motive to do that may differ from time to time. Well, there has to be a motive. Or else why will we part with our money? It would be rather stupid to do so unless it was for a purpose.

Sometimes, we just need to keep our earnings aside to be used later. But we cannot just leave them around. For like fish and milk they are perishable. A bacterium called ‘inflation’ eats them away. So we invest them. There they grow to hopefully make up for what the inflation eats way.

Sometimes we invest just to grow them even beyond what inflation may eat way. We want thereby to create an additional source of earnings so that ten years or twenty years down the line we have more earnings than today. That is investment- an instrument to make money grow.

But insurance is something entirely different. The need for insurance arises out of our uncertainty about future. I know I may need some money in future. But I do not know when. If I knew that the need would arise after sufficiently long time I would save and invest and be ready for it. But I do not know.

The need may arise very soon, not very soon or it may not arise at all. For instance, I know I will die. But I do not know when. If I die very soon it will cause a financial distress to my dependents. But if I die when they are no longer dependent on me my death will not cause any financial distress. It is all uncertain.

In such circumstances I cannot invest to meet that need. For investment needs time to grow to meet its objective. But when time is an uncertain variable I have to resort to insurance. I pay a risk premium (insurance premium) regularly. Like me many more persons pay the risk premium.   All these premia are pooled together.  The amount is then used to pay to the dependents of that person or those persons who die. In this manner I can shift the risk of my death to a group.

The financial distress that may be caused by my death is taken care of by the entire group rather than by me alone. But this arrangement has a cost. If I do not die, the premia paid by me are not utilised by me. I lose them in a sense that they serve to relieve the financial distress of the dependents of some other person.  

That is the basic difference between investment and insurance. So they cannot be obviously interchanged and one cannot be used for the other. Yes, they look alike; they are often sold at the same shop. Worse still they may be packaged together. You buy five kilos wheat flour, you get a kilo of sugar free; unfortunately sometimes in the same bag. Then what do you do? Do not buy it.

Make a point to keep the two apart. When you need investment buy investment. When you need insurance, buy insurance; as much as you want.   There is however one situation which may leave you quite confused, viz., insuring your investment. Let us take a situation like this.

You want to save and invest regularly for your child’s higher education. The need for this money will arise ten years down the line. So right from now you save RM1,000 every month towards that goal. But what happens, if, God forbid, you die after five years? Your plan and your dream for your child may then go haywire.

To prevent such a situation you can ‘insure’ your investment plan by buying a unit linked endowment plan (ULIP) with waiver of premium rider from an insurer instead of a plain investment in a bank FD or a mutual fund. Instead of a regular investment installment you pay the endowment premium. In the case of your death the insurer pays the premium on your behalf and your investment plan is completed.

So do not mix up investment and insurance even if everybody tells you they are the same. For them they may be the same since either gets them commission. But for you they cannot be the same. Do not walk with an umbrella when what you need is a walking stick.