Insurance is protection, not for your life and limbs, but for your assets. When you start building wealth early in life, you only have the human asset to depend on. You hope to have a job, earn an income, and build some assets for yourself. If you have a family that depends on your income, their lives also depend on human capital.
Insurance is your tool to make sure the wealth you plan to build is there, for you and your family, in case something happens to the human asset that could affect your ability to earn an income. Your insurance proceeds will kick in and compensate you, if there is a loss of life or limb. That’s why calculating how much insurance you need takes into account income, expenses and savings. You choose the goal you want to set for your wealth.
This is why insurance is needed earlier in life. Act as a shield that protects your wealth. It is not an investment, even if it is sold as such. It progressively becomes expensive to buy insurance if you want it to work as an investment as well. Term insurance is the cheapest as it serves the primary purpose of providing lump sum financing to your dependents if you pass away. If you feel you must provide for your child’s higher education, you have the option of comparing term insurance and an investment product separately before combining them. We deviate.
My friend won’t need insurance when he’s 65 because he’s almost at the end of his earnings phase. Ideally, he would have enough assets saved for his retirement and old age. It would be expensive and superfluous to try to buy another cover of the same value. My friend should know that he doesn’t need insurance if there is enough accumulated wealth. That he is getting older and a greater risk to the insurance company is the insurer’s side of the story.
That you find it expensive to buy health insurance is an extension of that story. We are living through that transition in India as corporate interests and insurance companies take over healthcare. Treatment options are unnecessarily elaborate and expensive to fuel service providers’ revenue goals. It’s hard to find an affordable health insurance option for a senior who also has pre-existing medical conditions. My friend raises a fair point, but the answers must wait for another column for the space the question needs.
Now to the mortgage loan. A loan is just a facility to use tomorrow’s income today. It is always an expensive option to exercise. The loan interest is the price to pay for this facility. A loan is useful when there is enough income to pay a installment but not enough wealth to buy the asset today. Most would not have been able to own a home if it weren’t for this facility, even if it does come at a cost. The lender will be primarily concerned with the value of the asset being financed and the borrower’s ability to pay.
My 65 year old friend does not need this expensive option. He has enough money in his retirement capital to be able to buy what he needs. If he were to use his assets as collateral, he could still get a loan. But he would have to pay it back with his investment income, now that he is retired. The math won’t work. His assets may earn less than the interest rate on the loan. It will not make sense to take a loan; His focus should be on optimizing the return on his investments and assets and adopting an income and expense orientation, rather than trying to build new assets.
That brings us to your investments. There is nothing wrong with keeping one’s money with the government. Lending to the government is the technically correct thing to say. Safe, as you know my friend. But that’s why the government gets away with paying the lowest interest rate. In the loan market, the rate at which the government borrows is the base rate. Nobody can borrow cheaper than that. There is no question about the government’s ability to meet its obligation to pay interest and repay principal. You can unilaterally raise taxes; borrow abroad and in the worst case print money. But that’s the borrower’s side of the story.
As a lender, my friend should ask himself if he is being too conservative by settling for a low rate of return. The answer isn’t to swing wildly to lend to the neighborhood finance company offering an amazing rate. There are many sensible options in between. Managing the retirement corpus needs a strategic approach to allocating how much to invest and where. Some amounts for growth in capital assets, some in quality income assets that offer good interest, some for security, and some for retirement and easy use. A combination that keeps risks low and returns optimal. Blindly choosing a form of investment is clearly suboptimal for risk and return.
Now for the ultimate reverse mortgage bombshell. The product is simple. Instead of taking out a loan and building an asset, you sell the asset up front to enjoy an income stream. The lender buys the house from him for a price today, but agrees to pay him a monthly installment over many years, at the end of which he takes over the house. You continue to live in the house, while earning an income. The reverse mortgage is an emergency option; not a normal one. You give up the appreciation of your home value, in exchange for desperately needed income. If you only have a house as an asset and no other wealth or income, a reverse mortgage is your last option. Don’t treat it like a regular income option.
These are all very simple and oft-repeated fundamental principles. But it is scary to see that many hold these notions with great conviction.
(The author is president of the Center for Investment Education and Learning.)