The Deceptive Allure of 'Safe' Investments

An insurance agent visited my home and presented an enticing insurance policy offer. Under this policy, I would commit to an annual premium payment of 3 lakh rupees for 12 years. Starting from the 13th year, the insurance company pledged to disburse 2 lakh rupees to me annually for the ensuing 28 years. Additionally, upon the culmination of the 40th year, I would receive a lump sum payment of 1.65 crore rupees.

The agent provided an easy-to-understand breakdown of the financials involved. The total premiums I would pay over 12 years amounted to 36 lakhs, and the cumulative sum I would receive in returns was calculated as 2 lakh rupees annually for 28 years plus the lump sum of 1.65 crore rupees, totalling 2.19 crores. Furthermore, there was an assurance that in the unfortunate event of my demise at any point within these 40 years, my family would receive an additional 50 lakhs.

Before I delve into the full narrative, I invite you to consider a single, fundamental question: Does this deal seem favourable to you? Without engaging in any calculations, not even mentally, take a moment to genuinely ponder whether this is a sound financial proposition.

It’s worth noting that to those with limited financial knowledge, this plan may appear exceptionally attractive. Surprisingly, this misconception ensnares more than 80% of the educated population. It’s precisely this allure that makes selling such financial products seem effortless. However, it’s essential to clarify that this isn’t a scandal, and all the figures provided are accurate. The real issue lies in the fact that the product sounds too good to be true, even when it is not.

The agent in question was no stranger to me; he was our trusted relationship manager, handling all our accounts at a leading private-sector bank. Even before he began to unravel the intricacies of the policy, I had an inkling that he might not be presenting a genuinely favourable product. This inkling surfaced when he employed terms such as “Lifetime opportunity” and “Exclusively for your family.” Moreover, he seemed determined not to disclose the policy’s annual rate of return or XIRR (Extended Internal Rate of Return), a crucial indicator of investment performance. His approach was marked by persistence, playing to both my anxieties and desires, and sharing anecdotes about how the wealthiest individuals in town had multiple similar policies in place.

In India, aside from physical assets like gold and real estate, a significant portion of family wealth is often tied up in financial products that fail to outpace inflation. The country lacks a robust equity culture, and this lack of awareness about the potential benefits of long-term compounding is striking.

If more individuals truly grasped the transformative power of compounding over the long haul, they would quickly recognize the opportunity cost associated with not venturing into equity investments. Traditionally, the stock market is viewed as the riskiest place to park one’s money. However, this perception is partly due to a widespread lack of understanding of what risk truly entails, which in turn, places the concept of risk management on the back burner.

Ironically, when considering an extended investment horizon, say, over 40 years, equity is one of the least risky asset classes.

Let’s illustrate the stark contrast between different investment choices with a concrete example. Imagine you invest 1 crore rupees each in a Nifty index fund and a financial product labelled as X, which guarantees a 7% annual return. For this comparison, let’s assume that the index fund achieves a Compound Annual Growth Rate (CAGR) of 10%. It’s a reasonable expectation for the Indian equity market over the long term.

After a decade, your investment in product X will have grown to 1.97 crores, while the investment in the Nifty index fund will have ballooned to 2.4 crores post-tax, even accounting for the inherent volatility associated with equity investments. The difference, approximately 43 lakhs, might not seem significantly better than the guaranteed returns from investment X.

Now, let’s stretch the investment horizon to a full 40 years. Your investment in X will grow to 15 crores, a substantial figure by any measure. However, the same 1 crore rupees invested in the Nifty index fund over four decades will soar to an impressive 43 crores post-tax. And let’s not forget that a 10% CAGR assumption is rather conservative for the Indian equity market. To put it in perspective, the Sensex alone has delivered a 14% CAGR over the last 40 years.

Consider for a moment the implications of such returns. An initial investment of 1 crore rupees at a 14% CAGR for 40 years would amass a staggering 188 crores. Yes, you read that correctly, 188 crores. There’s no error in the calculation.

Let’s circle back to the narrative and see how these investment principles played a pivotal role in my decision to decline the insurance policy. I had two choices on the table.

The first option was to purchase the insurance policy and commit to an annual premium of 3 lakh rupees (or 25,000 rupees per month) for 12 years. Starting from the 13th year, when I would begin to receive the annual payout of 2 lakhs, I planned to invest that money wisely. Specifically, I intended to channel it into an equity mutual fund through a Systematic Investment Plan (SIP) for the ensuing 28 years — equivalent to the duration of the payout. Assuming a conservative 12% CAGR on my SIP, at the end of the 40th year, my anticipated corpus would swell to a substantial 5.6 crores, post-tax, including the 1.65 crore lump sum payout. Additionally, should the unfortunate event of my demise occur during this 40-year span, my family would receive an additional 50 lakhs.

The second option I contemplated was to acquire a term insurance policy, designed to provide a life cover. This policy would disburse the sum assured only in the event of my demise and not under any other circumstances. Such policies are considerably more affordable, especially at my age, where I could secure similar coverage for less than 1000 rupees per month. Under this option, I would commence a monthly SIP of 24,000 rupees for the initial 12 years, allowing it to remain in the market for an additional 28 years, summing up to a total of 40 years. Remarkably, despite the two options offering similar benefits and perks, my estimated corpus under the second choice after 40 years would stand at a remarkable 17 crores, post-tax, compared to the 5.6 crores projected in the first option. Consequently, the opportunity cost of purchasing the insurance policy would be more than 11 crores over the span of 40 years.

These conclusions are not drawn from a vacuum; rather, they’re rooted in meticulously researched, modest assumptions, and supported by data. In both of these options, the same amount of money flows from my pocket, and my life is covered with a 50 lakh insurance policy. However, when you juxtapose the final figures after 40 years, a stark contrast emerges.

It all boils down to understanding several pivotal financial concepts:

Equity as an Asset Class: Equity, often viewed as a risky venture, can, over the long term, offer unparalleled growth potential.

The Impact of Slight Differences in Investment Returns: Even a few percentage points difference in investment returns can translate into significant variations in the final corpus.

Distinguishing Between Volatility and Actual Loss of Investment: Volatility in the stock market doesn’t necessarily equate to a loss of investment, especially when the investment horizon is extended.

The Power of Long-term Compounding: Lastly, and perhaps most crucially, is the power of long-term compounding. This principle can turn seemingly small investments into substantial wealth over time.

All these factors coalesced to make it abundantly clear that I should steer clear of financial products like the one presented by the agent. While the immediate allure of guaranteed returns might seem enticing, the long-term opportunity cost of such a decision is staggering.