It is likely that you have seen advertisements promising guaranteed returns in the form of a monthly income after investing for a certain period of time. The ads usually say: If you invest ₹15,000 a month for 25 years, you’ll make ₹40,000.
Guaranteed return plans are basically insurance plans. They sound appealing, because who wouldn’t want a guaranteed income? Plus, they promise to pay a fixed amount of money every month for a certain period of time. Investing in such a policy is also tax deductible, and you get a life insurance policy for the entire term of the policy. Does this sound good to you? Let’s explore this a little further.
The workings of guaranteed return insurance plans
Let us first understand how guaranteed return insurance works. According to Rahul Jain, President and Head of Nuvama Wealth, a wealth management firm, a guaranteed return insurance plan (non-participating plan) guarantees a payout for a defined period after the investor pays the premiums for the selected number of years.
a person, purchases a guaranteed return insurance policy with a 10-year premium term and a 30-year policy term with a two-year waiting period. In this case, he will first pay the premium for ten years. In the 12th year of the policy, he will begin receiving guaranteed payouts.
The plan offers regular cash flows and/or lump sum payouts based on the investor’s preference, making life easier for those who are not good with money management and are unable to generate regular income through fixed deposits and bonds. It may not be a good idea to invest in guaranteed insurance plans, however.
The misleading nature of the claims on guaranteed returns
According to Renu Maheswari, co-founder and principal advisor of Finscholarz Wealth Managers, the numbers in the policy are only numbers. There are no percentage figures that specify the returns. When a percent return figure is mentioned, it will be “up to” or “as high as” 7.5%, which is a misnomer since they are advertised as guaranteed return plans.
Maheswari says the numbers do not make sense – one number is for 2023 and the other number is for 2048. The time value of money is not taken into account in these numbers. Suppose that the investor wants to receive 40,000 dollars per month today, but after 25 years, it won’t be the same amount. Due to the lower purchase value, planning is completely out of the question.
Here are some reasons why you shouldn’t invest on guaranteed returns
It is never a good idea to mix insurance with investments. Guaranteed insurance plans also have lower returns.
It is not clearly stated where we are getting the return. As registered investment advisors (RIAs), we look at the numbers and calculate the IRR, based on which we judge the policy,” says Maheswari.
These plans can yield IRRs between 6% and 6.50 % in the current interest rate environment. Jain says it is easy to calculate the IRR of these plans. The investor just needs to plot the premium expense and future income flows from the benefit illustration and use the IRR function to calculate the IRR. Generally, guaranteed return insurance plans have lower IRRs.
When investing in such a product, you are largely committing your money to a structured investment. Most of your funds will be placed in fixed-income securities. If given the option to invest for 25-30 years, you could potentially double your gains through the equity markets, according to Maheswari. Unfortunately, guaranteed insurance plans won’t beat inflation, and over time this will not help you grow your wealth.
There are investors who are risk averse and do not want to invest in equities. A guaranteed return insurance plan is not the best investment for them. A conservative investor would buy a term plan and invest the rest in RBI savings bonds, according to Gaurav Mashruwala, financial planner and author. A floating rate bond’s interest rate is reset every six months, and it is currently at 8.05%.
Such a product gives you a false sense of security, but from a financial perspective, it is not a wise purchase.