What if there was an investment opportunity which proposes to earn a CAGR of 7.25% (after tax) for 22 years. Would you jump at it?
Despite the numerous legalities of the fine print, insurance products which mix investment have been a huge success in India. Many of us are happy as well with these insurance products without actually knowing the returns generated by such “investments”. This got us wondering how people could ignore such a crucial detail in case of insurance-cum-investment products, especially when they check the minutest of details in case of their other investments.
We seem to have got our answer when recently, one of our clients was approached by an insurance agent with a product which proposed (not guaranteed) annual payments after the premium paying term along with a lump sum bonus at maturity. Basically, this product works as follows:
- You have to pay a premium of Rs. 25,000 per annum for an insurance cover of Rs. 2,50,000 (As most of us know, insurance coverage is the least of the concerns in these products).
- The premium paying term is 7 years. So you end up paying Rs.1,75,000 in total.
- You start getting Rs.20,000 back annually from the 8th year onwards for 15 years. Further you are likely to get around Rs.1,10,000 in the final year as bonus. So, in total, you get Rs.4,10,000 (obviously ignoring the time value of money).
In absolute terms, paying Rs.1,75,000 for getting Rs.4,10,000 looks pretty good. Right? However, when we get down to some number crunching, this investment is exactly the same as the one posed in the question right in the beginning of the article, i.e. the CAGR of this investment is 7.25%. What further adds to the woes is the fact that this return is not guaranteed and is merely an illustration. Generally, the actual return is lower. We all know that there are plenty of investment options which can earn much more than 7.25% over such a long period of time.
What insurance companies count on is a good marketing package and hope that the lay investor does not sit down to actually work out the return on the investment. I am sure, most of the insurance agents don’t even know how to calculate the CAGR of their investment products.
So the next time an insurance agent knocks on your door and tries to sell you an investment plan, do calculate the proposed return of the plan before actually purchasing the product.