Mutual Funds Investing Strategy 105: Fund Your Insurance Costs Through A Mutual Fund
Last week we discussed how important an insurance product is. We also discussed why term insurance is much better than an endowment plan, money-back scheme, or a Unit Linked Insurance Plan (ULIP). One of the reasons is that we are a better investor via the MF route.
If you have not read that chapter yet, please do now.
https://viswaram.com/insurance-strategies-101-term-insurance-or-endowment-plans-5305ee32ee8a
The realization that insurance costs are an outgo with no returns is a true measure of wisdom. Insurance is an intangible product and you cannot see, touch, or feel its importance — only when you pass away, the benefits start.
In this article, we will discuss how you can earmark your annual insurance costs in such a way that it does not seem like a liability. We will be using calculators to financially model the outcomes.
The assumptions are:
- 30 year old man, Ramesh.
- 27 year old wife, Radha.
- daughter 4 years old
- son 2 years old
- Owns a 4-wheeler, no two-wheeler.
The insurance required by this family is:
- Separate life insurance for Ramesh & Radha — 1 crore each.
- A family health insurance for the 4 members
- Motor insurance for the 4-wheeler.
Now let us calculate the costs
1. For Ramesh, a 1 crore life insurance plan will cost approximately Rs11918 per year.
2. For Radha, a 1 crore life insurance plan will cost approximately Rs9086 per year.
3. Health insurance for the family will cost Rs16658 per year.
4. Motor insurance on a 5-year-old car will cost approx Rs7000 per year
If we sum up all the insurance costs quoted above, we get 11918 + 9086 + 16658 + 7000 = 44662 per year.
Ramesh & family have a conscious decision to make — whether to stay insured or not. Except the motor insurance, life and health policies are not mandatory products — and the family could even skip those. A sensible and educated family should never skip the life & health cover.
If you feel like you are paying Rs44662 per year on a lost cause, we can find a solution for it. We can fund the plan with a simple fixed deposit or a debt mutual fund.
Case1: Funding via a fixed deposit.
We need to calculate the value of the fixed deposit required so that its annual interest equals 44662, the easiest way is to find out the deposit rates of SBI and then reverse engineer it.
A 3 year FD will give you 7% interest, so the amount of FD required = 44662/7% = Rs6,38,028 ~ 6.4 lakhs.
If you save 6.4L via fixed deposit and lock it in a bank, it will take care of your annual insurance costs.
Why did you not think of this idea earlier?
Case2: Fixed Income Debt Funds
Fixed income debt mutual funds are a better choice than fixed deposits due to their tax friendliness. You could buy the mutual fund with a payout option or growth option.
In the payout option, you will get the returns in hand and you could offset the insurance costs. Whereas in the growth option, you could see your money getting compounded — you need to imagine the costs of insurance getting offset in this option.
You will get the option to keep the payout option as either
- Growth
- IDCW (Income distribution cum withdrawal)
The growth option will cumulate your interest whereas IDCW will payout the interest component.
The amount you need to invest in this scheme is 44662/9.38% = 4,76,140 ~ 4.76 lakhs. However mutual funds cannot promise exact returns all the time — the actual returns could be higher or lower depending on the instruments the SBI fund manager buys. Since these are debt funds, the variation won’t be that much, so let us assume an initial deposit of Rs5,25,000 would suffice.
As a 30 year old, you need to keep away approximately 5.25 to 6.4 lakhs one time in an interest bearing instrument to compensate your insurance costs. Take your time to think through, even if you spend a full Sunday on this possibility — I would say it is worth it. Insurance to me is a mandatory product, all you need to do is find an income source to pay for it.
Calculators are for illustrations only and do not represent actual returns.
Mutual Fund investments are subject to market risks; read all scheme-related documents carefully.
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Disclaimer: Mutual Fund investments are subject to market risks; read all scheme-related documents carefully.