Insurance policies should play a major role in your plan to become Financially Independent. However, don’t mistake insurance for an investment!
Insurance companies are quick to sell you policies that combine insurance (usually life insurance) with investments. These policies usually go by the names of “whole life” or “universal life” but they’re any policy that insures something while building a cash value.
Stay away from these products because they’re good for the insurance companies but bad for you. For the price, you get much less insurance and less investment growth than if you bought the two separately.
If insurance companies didn’t make a lot of money from these policies, they wouldn’t sell them. They make money by investing and earning money you pay in premiums. Then they charge high expenses, administrative costs, and management fees which severely decrease the earning power of the investment portion of the policy.
Insurance companies are counting on the fact that their customers will collectively pay much more in premiums than they’ll have to pay out in claims to a relative few people.
There’s no valid reason why you should combine insurance and investments together. Just because you can doesn’t mean you should.
The purpose of insurance is to mitigate the risk of a big financial emergency. You pay a relatively small amount of money in the form of premiums. In return, the insurance company promises to pay for any catastrophic emergencies that are covered by that policy.
What Role Should Insurance Play in Your Investment Plan?
I just slammed insurance companies for trying to sell you insurance policies combined with investments. But, insurance policies do play an important role in your investment strategy.
You’ll work hard to save and earn money to create wealth for your Financial Independence. It’s important for you to protect that wealth to become Financially Independent. You can protect your investments and your family’s financial health by having insurance.
A natural disaster, major medical issue, automobile accident, lawsuit, or other financial emergencies can cost you hundreds of thousands of dollars—much more than you’re likely to have available.
A single event like that can ruin your entire financial life. Not only might it cost you all your savings, but it could mean that you’d be paying for this emergency for years to come—possibly for the rest of your life.
What happens if you have a large mortgage on your house and it burns down without being insured? You’d be forced to pay off that mortgage without getting anything in return. You’ll pay hundreds of thousands of dollars for a pile of ashes, and you’ll still need to afford to somehow pay for a place to live.
Medical costs are high and going higher. If someone in your family had a medical emergency without insurance, you can be faced with the same situation.
When you’ve worked most of your life to save and grow your wealth with the goal of being Financially Independent you need to protect that investment the best you can.
Insurance Is Very Expensive
I understand why many people balk at buying insurance. It’s expensive and it’s the one thing in life that you buy hoping you never need to use. In some respects, it feels like giving hard-earned money away and getting nothing in return. But, you get the assurance that your policy will pay should a covered financial emergency arise.
Insure Your Life with Term Insurance
You can literally insure anything…for a price. But the big 4 that most people need are automobile, homeowners (or renters), health, and life. Life insurance is possibly the most frustrating of all. You pay money for years and you’ll never receive a benefit for it. It only pays your beneficiaries if you die while covered.
You need life insurance for the financial security of your family. You should insure the lives of anyone in your family who’s earning an income that’s used to support the family. Most of the time that means the husband and/or wife, but in some rare cases where a child is an income earner, such as a child actor, a child’s life may need to be insured.
Instead of buying an expensive whole life policy, purchase a term life policy. A term life policy is held for a specific term–usually, 10 or 20 years. At the end of the term, the policy expires at which point you may need to buy another term life policy.
This policy is straight insurance and much cheaper than a whole life policy. You’ll get much more insurance for a much lower cost.
Take the money you save on premiums and contribute that to your IRA or 401(k). By separating investments from insurance you’ll be able to invest in products that directly support your investment strategy while saving a bundle on administrative costs and fees.
How Much Life Insurance is Enough?
I recommend having at least 20-times the annual income you need to replace. For example, if the income producer earns $40,000 a year for the family they’d need a policy that’s 20x more–$800,000 at a minimum.
If your family then invested that money at 8% per year (on average) they’d be able to take 5% of the money ($40,000) as income and still have some left over for growth. Growth is necessary so the amount used each year can increase due to cost of living and growing family needs.
In this case, your family would start off with $800,000. In the first year, it would earn 8% (on average) or $64,000. The family would take $40,000 to replace the lost income and the $800,000 would grow by the difference ($64K – $40K = $24K) to $824,000.
The next year the family could use 5% more money ($40,800) than the previous year. The lump sum would continue to grow allowing the amount used each year to grow by 5% over the previous year. In this manner, the money would never run out. In fact, it would more than double over the next 40 years even after supplying the family with nearly $2.5 million of income during that time!
If your plans call for paying off a mortgage or college tuition, you’ll need to add that in as well. To replace a $40,000 income and instantly pay off a $200,000 mortgage you may need $1 million of life insurance.
The Goal of Being Self-insured
I used to have a 10-year term life insurance policy that ended when I was in my late 50s. Just before the policy expired a representative from the company called me and asked if I’d like to renew with another term policy. I told him that I didn’t need to. He asked why, and I told him I was now self-insured. He said he didn’t understand. I told him that I now had saved enough money so that if anything happened to me my family would be taken care of. He acted like that was the strangest thing he’d ever heard of.
That was my plan all along when I bought that policy. At that point in life, I didn’t have enough savings for my family to replace my income if something happened to me. But I knew that in 10 years I should be able to save/grow enough, which I did. When it came time to renew the policy I could pass on it and keep the money that I’d been paying for monthly premiums.
It takes hundreds of thousands or even millions of dollars to self-insure for life. So, it’s not that easy for everyone to be in that position. However, there are things you can do instead that are within your reach.
Cover Deductibles with Your Emergency Savings
When you first buy an automobile policy you may not have the resources to cover a large deductible if you have a claim. You’ll have to pay extra for the premiums, but you can have a small deductible of maybe $250. This means the insurance company will pay for any damage to your vehicle after you pay the initial $250.
If you were to put $500 into your emergency savings and earmark it for automobile deductibles you could then call the insurance company and raise the deductible on your automobile policy to $500. Then take the money you save on premiums and add that to your emergency fund until you have $1000 saved. Call your insurance company again and raise the deductible to $1000 allowing you to save even more on your premiums.
The more self-reliant you are with your finances, the less you must pay someone else to help you—in this case, the insurance company.
Why is This Important to You?
You’ll work hard to save and earn money to create wealth for your Financial Independence. It’s important for you to protect that wealth. One way to protect your investments is by having insurance. But there’s no valid reason why you should combine insurance and investments together.
About the author: I’m Nicholas H Parker, a writer for buy essay online service. Previously I worked as a financial analyst. This occupation gave me an opportunity to elaborate tips on doing right investments.