Term policy + SIP: Is it practicable?

All the financial planners and the TV channels on finance have been propagating the idea of
buying a term insurance plan in place of a traditional one, and to invest the difference in
premium in a mutual fund scheme through SIP with a long term horizon, say of 20 years. Yes
it is a prudent advice and yes the investment in mutual funds through SIPs has proven to be
good in long term despite the volatility of the markets by the principle of Rupee Cost
Averaging.
This mathematical calculation looks attractive on paper but the advice ignores the
psychological character of the investors. The psychological character of investor is related to
the character of the instrument. Let us examine this point briefly:

1. At the time of liquidity pressure
The Term Insurance policy is the basic, the cheapest and the best instrument for life risk
cover, there is no denying about it. Although it covers only risk and does not have any
investment part in it, a person tends to consider what does he get at the end of the term if
he survives, howsoever you may convince him. He gets initially convinced and buys a term
policy but over a period of time when there is liquidity stretch, it is more likely for him to
stop paying premiums of a term policy as the original sentiment of ‘ what am I going to
get?’ crops up and the obvious answer is, he is not going to get anything ! At this point of
time he does not consult the financial planner but stops paying premiums and the policy
along with his credibility with insurance company lapses.

2. Stays unprotected in case of lapse
At this stage he stands totally open to risk because the single big cover to protect the risk is
removed.

3. Easy liquidity character of mutual funds
Mutual fund investment has easy liquidity (except ELSS where each installment has 3
months’ locking period) and without any loss. So apart from stopping term policy premiums
which enables him to reduce pressure, he finds the easiest way to redeem his mutual fund
investment partly or wholly to make good the cash crunch.(Here it is assumed that the
mutual fund investment is made in equity funds and the redemption is made after at least 3
years thus there will not be any capital gains tax on it).
Another issue is the period in which the SIP is started. If it is started while market has risen
to the peak and then the decline starts or if there is a market crash, people tend to over
react and redeem the units and the basic principle of Rupee Cost Averaging is neglected.
According to the data of Computer Age Management Services (CAMS) during decline in

markets in 2012 it was seen that many investors exit their SIP accounts before completion of
tenure. The net SIP registrations had been negative during this period.

4. The character of the traditional endowment type insurance plan:
The Endowment type insurance plan or any cash value plan is a combination of risk cover
and investment. Compared to term plan it is very costly and compared to mutual funds it
has very low potential of growth in investment. It has low level of liquidity and there is
always loss on surrendering the policy. The investment advisors are often seen to ridicule
this plan saying the yield on it is just 4% or 6% etc. I am yet to know the formula of arriving
at such conclusion because if the Sum Assured and the Term is same (and therefore the
maturity value is also same) the yield is inversely proportional to age of the policy holder.
However the fact is the yield is low. Actually these become positive and not negative points
considering the psychological character of average investor / policy holder. The reasons can
be as enumerated:
a) The cash value on surrendering of the policy results in loss so he opts not to
surrender it but to avail of loan if possible, against it.
b) Even if he stops paying premiums after the policy attains minimum cash value, his
risk cover gets reduced but doesn’t get entirely ceased.

c) If he continues the paying premiums till maturity he gets some cash value.
d) He can revive the policy once his liquidity crunch is over (within stipulated time) in
much easier way than the term policy.

5. The best combination is therefore Traditional Plan + Term Plan
If there is a combination of traditional plan and a term plan to give the person adequate
cover considering his Human Life Value (HLV), there is lesser possibility of losing entire
cover and loss in cash value. Even if he stops paying premiums of term policy , which is not
advisable, but normally followed by people, he still has some risk cover, if not adequate, by
way of a traditional policy.
At the end of this article I can’t resist myself from sharing a joke on futility of mere
mathematics in life:
A simple and much disciplined gentleman once met a smoker. The gentleman asked the
smoker,
‘How many cigarettes do you smoke in a day?’
‘10’ answers the smoker.
‘And what is the cost of one cigarette?’
‘Ten Rupees”
‘How long have you been smoking?’
‘last 15 years’ admits smoker.
‘Look, if you had not smoked and saved money that is Rs.100 /- a day or Rs. 3000/- per
month, you could have been a proud owner of a Mercedes Benz.’
The smoker released a puff of smoke from his mouth and asked the gentleman,
‘Do you smoke?’
‘ No never, I m 55 years old now and my health is strong, no BP, no diabetes, nothing at all..’
.
“WHERE IS YOUR MERCEDES BENZ?”