Insurance and Investment are two different concepts, although they both involve money and risk. Despite this, many people still consider insurance as an investment, which can lead to confusion and unrealistic expectations. It’s important to note that insurance and investing are two different financial products, and each serves a different purpose. While insurance provides financial protection, investing is a way to grow your wealth over time. It’s essential to have a balanced financial plan that includes both insurance and investments to achieve your financial goals.
Let’s say you pay ₹10,00 per year for your auto insurance policy. You’re not expecting to make any money from your auto insurance policy, but you’re happy to have it in case of an accident. Your insurance company is assuming the risk of a car accident, and you’re paying a premium to transfer that risk to the insurer.
As an alternative, suppose you put ₹10,00 into a stock in the hopes that it will rise in value and you can sell it for a profit. Yet, in this instance, you are taking a risk by purchasing the stock in the hope of making a profit. The main distinction between these two names is found there.
Insurance: Risk mitigation
An agreement between a person or business and an insurance provider is known as insurance. In exchange for a premium, the insurer undertakes to pay for specific losses or damages in this. Insurance is designed to protect against risks that are beyond the policyholder’s control, such as accidents, illness, natural disasters, or theft. Insurance policies can provide financial protection for individuals and businesses, by covering the costs of medical treatment, repairs, or replacement of property, liability claims, and other unforeseen events.
The Indian insurance market earned INR 6.15 trillion in gross premiums in the fiscal year 2020–21, an increase of 11.3%, according to the Insurance Regulatory and Development Authority of India (IRDAI). The overall quantity of investments made in India is not, however, monitored by a single regulatory body or department. The mutual fund industry in India had total assets under management (AUM) of INR 37.7 trillion as of January 2022, according to SEBI, the regulatory body that governs the country’s capital markets. To reach financial objectives, it is crucial to have a well-balanced financial strategy that incorporates both investments and insurance.
Why insurance is not an investment?
Insurance is rarely regarded as an investment even though it can offer financial security and peace of mind. These are some explanations:
Lack of ROI:-
One of the main differences between insurance and investment is that insurance policies do not offer a return on investment. The policyholder’s premium pays for the insurance company’s risk, administrative expenditures, and profit margin. Unlike investments, such as stocks, bonds, or real estate, insurance policies do not generate income or capital gains.
For example, let’s say you pay ₹2,500 in annual premiums for your car insurance. If you don’t file any claims during the year, you don’t get any money back from the insurance company. On the other hand, if you invest ₹2,500 in a stock that pays a 5% dividend, you will earn ₹125 in passive income.
Another reason why insurance is not considered an investment is that it has limited upside potential. Insurance policies are designed to provide a safety net in case of a loss, but they do not offer the same growth potential as investments.
For instance, let’s say you invest ₹10,000 in a stock that grows by 10% in a year. Your investment will be worth ₹10,797 at the end of the year. On the other hand, if you pay ₹10,000 in premiums for a life insurance policy, your beneficiaries will only receive a payout if you pass away.
Risk Transfer, not Risk Taking:-
A third reason why insurance is not an investment is that it involves risk transfer, not risk taking. Insurance policies are made to shift a loss’s risk from the policyholder to the insurer. The insurance company assumes the risk of paying for the losses covered by the policy, in exchange for a premium.
Insurance is typically purchased to cover short-term or medium-term risks, such as health emergencies or car accidents. A longer time horizon is often considered while making investments, such as retirement or long-term financial goals.
Investments, on the other hand, involve taking on risk with the expectation of generating a return. When you invest in a stock, bond, or mutual fund, you assume the risk of market fluctuations, inflation, and other variables that can affect the value of your investment.
Term Life Insurance vs. Investing in a Mutual Fund
Term life insurance is made to provide financial security for your dependents in the event of your untimely passing. A death benefit is paid to your beneficiaries if you pass away within the policy’s term. Term insurance has no provision for savings or investment; it only serves as a kind of protection.
On the other hand, let’s say you invest ₹1,00,000 per year in a mutual fund that tracks the stock market. If you want to grow your wealth over time, mutual funds could be a good option to consider. You’re taking on risk by investing in the mutual fund, with the expectation of earning a return on your investment.
Homeowners Insurance vs. Investing in Real Estate
Your home and personal property are protected from damage and loss by homeowner’s insurance. You pay a premium to the insurance company, and in exchange, they assume the risk of covered events such as fire, theft, or weather damage. Let’s say you pay ₹3000 per year for your homeowners insurance policy.
On the other hand, let’s say you invest in real estate by purchasing a rental property. You’re hoping to earn rental income and increase the value of the property over time. You’re taking on risk by investing in real estate, with the expectation of earning a return on your investment.
In each of these examples, insurance and investment serve different purposes and offer different benefits. Insurance provides protection against risk, while investment offers the potential for growth and return. While both can be important components of a financial plan, it’s important to understand their distinctions and not confuse them with each other.
In conclusion, Insurance and Investment are two distinct financial concepts that are often confused with each other. While both involve money and risk, insurance primarily provides protection against risk, while investment offers the potential for growth and return. Insurance is not considered an investment because it does not generate any returns or profits for the policyholder, but rather provides financial protection in case of a covered event. Understanding the differences between insurance and investment can help individuals make informed financial decisions and develop a comprehensive financial plan that includes both insurance and investment components.