Investment Linked Policies or ILPs have been an ideal target to be bashed by many personal finance groups and investment gurus. In your wealth management journey, perhaps an agent might have ethically (common assumption used by those groups/gurus) told you or sold you an ILP before. Hence, you might start to think whether the ILP does make sense for you.
These Groups/Gurus’ bottom line: Cancel Your ILPs. The fees are expensive. Buy term, invest the rest. You can get better investment returns.
Wealthdojo’s bottom line: ILP is suitable if you are looking for a booster in coverage for a short period of time and plan to accumulate shares/units in a systematic way. You have a more passive approach to investment. An ILP works ideally when you are younger.
So what now? Disclaimer aside, I hope to share with you 3 brutal truths on ILP and the current narration on ILP in the market.
Investment Linked Plans are policies that have life insurance coverage and investment components. Your premiums are used to pay for units in one or more sub-funds of your choice. Some of the units purchased are then sold to pay for insurance and other charges, while the rest remain invested. (Moneysense Definition)
In a layman structure, it looks like this.
Pay Premium > Buy units of the funds at today’s price > Some units are sold to pay for insurance > Wait for next month premium
The units accumulates every month via dollar cost averaging and will build up substantially in a long run. Let’s go on to the brutal truths for ILP.
Truth #1: You will pay fees.
This reminds me of a story of a man buying cake for his son’s birthday. After looking at various cakes, his eyes soon fell on a 7-inch strawberry fresh cream cake that stood at the center of the display. This shop is famous for their fresh cream and his son loves fresh cream.
Man: “This cake looks beautiful. How much is this cake?”
Baker: “It costs $97 sir”
Man started to be agitated: “That’s ridiculous. It is just a bunch of strawberries, flour, eggs and sugar. This is a rip-off!”
Baker said calmly: “Sir. You are right. Therefore, we have something just for you”
The baker brought him to the corner and showed him a bunch of strawberries, flour, eggs and sugar and said: “Those will be $13”
Man: “I don’t understand. What do I do with a bunch of strawberries, flour, eggs and sugar?”
Baker: “Well, that’s what we are paid to do.”
The simple truth is that there will be fees. When you enroll into an ILP, you are paying for insurance, you are paying for wealth management and miscellaneous administrative fees which includes commission for the consultant. You are paying to enroll to a service which consist of insurance protection and investment accumulation.
The narration in the market is that an ILP’s charges are expensive and expensive is a subjective word. Perhaps, it is better to put things side by side with insurance and investment.
Let’s take a look at insurance. I will be comparing our National Insurance Dependent Protection Scheme (DPS), as compared to XXX company’s ILP charges per age band (I personally believe the charges are very similar across companies). We will compare using a basis of $46,000 sum assured for Death and Total Permanent Disability (TPD).
As you can see, the charges for XXX’s company is lower than DPS for all ages except for 55 to 59. This shows that rates are quite competitive. As you become older, you pay more for insurance as the chances of you suffering from Death and TPD increases.
You can also see an element of the popular advice buy term invest the rest here. On an ILP, we contribute a premium monthly. Part of it is used to pay insurance. In the table, we pay for the required insurance charges at that age and the rest goes into investment. If you add on other unit deducting riders like critical illness and early critical illness, you should pay more premium so that you won’t have too little going into investment.
Note: DPS is due for a change and there could be a chance the insurance companies might follow as well.
Let’s talk about investment now. As the strategy for an ILP is mostly passive, it might not be a fair comparison to other investment methods that might be more active. I will give an attempt to compare the fees across various personalities.
The current narrative from investment gurus are that the ILP has high upfront charges of up to 50% of the premium. It is the same for investment courses as well. They do charge a high upfront course fee of around $3000 to $5000. Furthermore, I assume there are no other upsell programs after that.
Another common narrative is that the 1.25% p.a. fund management fee will reduce the investment returns in the long run. This is a true statement as any expenses will reduce your investment returns. Recently, investment courses are also changing to provide continuous support at a fee of $49 to $197 per month. This is akin to having a “fund management fee”.
For those that are self taught investors, he/she might have save on the cost. However, I can only imagine how huge the time commitment he/she dedicated into learning how to invest. One can say to invest in a passive S&P500 index fund with low expense ratio. Then again, how long will you take to reach this decision? How many mistakes might this person make before doing that?
Fees will have to be paid. It is just a matter of to who and how.
Side note: It may not be fair to compare anyway. An investment course does not have insurance coverage. Similarly, an ILP is not an active strategy as compared to some investment courses. The lessons you learn from investment courses are also priceless.
Truth #2: If you pay peanuts, you will get peanuts.
Whether it is an ILP, endowment or ETF, if you pay peanuts, you will get peanuts.
This is rather straightforward. I know some people who may have unrealistic expectations on the money they are saving or investing. A $100/month policy or a $100/month ETF is not going to buy you your financial freedom. If you invest $100/month for 30 years with an 10%, you will get $197,392 which is decent but definitely not enough for retirement.
This year, I presented a few maturity cheques varying from $15,000 to $60,000 to some of my clients. I excitedly told one of my clients that his maturity cheque is coming in August 2020 and told him to look out for it. He took me out for coffee and asked me how much he was getting. After checking my portal, I told him the amount was $22,000.
He took a sip and exclaimed “Why only $22,000? I has been paying for 25 years.”
“Uncle, you were saving $50/month. In total, you saved $15,000. Personally, I think this is a decent return.”
A short while later. He confessed that he should have saved much more when he was younger.
Imagine there is an investment that can give you 100% returns. If you invest $100 in it, the maximum you will get back is $100. $100 in absolute is not a lot. Therefore, it is very important for us to save up our first pot of gold or simply increase the amount of regular contributions every month.
Truth #3: Not everyone you meet will be interested in investing
Sometimes, we forget that we look at others with our tinted lens. We tend to judge a decision and call foul when it is a decision that is not consistent to our own belief. In a recent viral article, a young couple in their 30s paid off their $470K HDB loans in 2 years.
This is a feat that is not easy to many. However, this sparked off a huge debate on many personal finance groups saying how financial “Illiterate” they are. They could have made use of the low interest environment to pay off their loans and use the money to invest in other things.
First, I would like to congratulate them. They are debt-free and it is something money *ahem* can buy. If their objective in life is to live a life that is debt free, they are already successful.
Not everyone you meet will be interested in investing or willing to spend loads of time to look into investment. Therefore, the ILP gives a simple disciplined dollar-cost-averaging strategy to accumulate the units of the recommended portfolio funds.
If you are a disciplined investor, feel free to buy term and invest the rest. Please do not expect everyone else to think like you.
Final thoughts by Wealthdojo
I’m not advocating ILPs. At the end of the day, the ILP is a wealth accumulation and insurance tool that can fit into a certain profile of individuals. It may be suitable for certain groups of individuals. Personally, I feel that the narration of the ILP has been viewed with tinted lens. Those people are right in their own aspects and life stages.
If you are unsure if the ILP is still suitable for you, please feel free to write in to me. I would love to help you understand it together.
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Chengkok, Sensei of Wealthdojo.