Recently I was asked why does the market have so much stigma towards Investment Linked Policies (ILPs) and if it has its place in the market? It's a good question which is overdue an answer I suppose.
For starters, many people till today are unaware that there are 2 different types of investment linked policies in the market now - protection based ILPs and investment based ILPs. They naturally serve different purposes and investment performance would also vary. If we are talking about investment returns, then naturally judging a protection based ILP for its investment performance is like wondering why a bicycle takes 2 - 3 times the duration of a car to get to a location, potentially saying that a bicycle sucks as a long distance mode of transport because you might even get wet when it rains.
(I actually own a car and a bicycle. However, I bought a bicycle to exercise and a car for transport so understanding its purpose is important.)
Incidentally, if you deliver Grabfood, they match your food order locations according to whether you walk, cycle or use a motorized vehicle. Common sense can probably explain why. Even if all are modes of transport, it's not the same.
Above all, in my opinion many consumers get swayed by the hearsay of the downside of investment ILPs but there's too little literature on its upside. Hence if you keep hearing something is bad without knowing why it might have its place in the investment world, then naturally your pre-conceived perception is bad.
In this article, I hope to provide a more balanced perspective. Also, why this investment instrument can help a certain group of consumers as part of their portfolio.
Understanding ILPs
I actually wrote about this topic in 2019: Investment Linked Policies And What You Should Know About Them
This was an infographic I put together in 2019. It pretty much sums up the difference. In short, many people are still judging ILPs based on their experiences with protection based ILPs. Often, they associate underperformance with these protection based ILPs which functions primarily for protection, not investment. If positioned otherwise, the product is pretty much misrepresented. Naturally, the expectations that comes with it would then be misplaced.
In today's context, it's important to know there's more than 1 type of ILP. For investments, an investment based ILP (largely defined as a 101 ILP by the industry) would very much be more suitable. One distinctive difference is that the cost of insurance can potentially be zero if the fund outperforms the principal invested and this is something that a protection ILP cannot achieve. For first time readers, cost of insurance for investment linked policies play a significant role in its impact to its investment returns especially for older age groups where the potential costs may be much higher. The initial allocation of premiums to the protection and investment components may also be a cause of consideration if you are looking for an investment vehicle.
People take up protection based ILPs primarily for flexibility and coverage. On the flip side, people take up a 101 ILP/Investment based ILP for investment and naturally investment performance is a primary expectation.
What are the key benefits of Investment based ILPs?
I've also written about a similar topic in 2020: 4 reasons why you may consider an investment ILP in your portfolio
Fees
To kick start this topic, I'd like to address everyone's favourite area of contention - fees.
An investment based ILP has certain core characteristics and one is long term regular investing primarily through dollar cost averaging. These investments are mainly into mutual funds. Now, if you do regular investing through an advisor or banker, typically the fee is averagely 3%.
Of course Robos and DIY is cheaper however, my personal experience with clients I work with is that many people have no interest to do their own research or even monitor their Roboadvisor on their own. (if you belong to that camp, your opinion might differ)
Back to the topic, there are investment based ILPs with cost much lower than 3% (when you average out) especially if you invest over a 20 - 30 year period. In fact, fees can get pretty competitive as plans evolve.
Additional Bonuses
On top of which, many investment based ILPs give start up bonuses. These bonuses vary insurer to insurer however, for the longer term durations, the bonuses can range between 10% to more than 100%. What this means is that the consumer gets additional funds invested into their portfolio through the insurer which further helps to mitigate the possibly higher initial fees. One consideration which might not be so obvious to the consumer is how the breakeven yield gets calculated. Often, consumers get put off by the high fees but overlook the additional bonuses that the plan provides which helps bring down the costs significantly. Other than start up bonuses, a number of insurers also provide extra bonuses upon the completion of the investment period and sometimes even midway. That's why it might be worth asking for the breakeven yield for the ILP you will be investing in before concluding that investing through ILPs is unreasonably expensive.
Disciplined Investing Mechanism
Too many people discount this. Sometimes, even advisors question its need.
The recent circuit breaker in 2020 gave me pretty good insight into human behavior. For clients who have been waiting for market opportunity, a sudden 30% plunge within 28 days actually caused them to adopt a wait and see approach. When they eventually invested, markets are back to its highs. Another group of consumers who experienced some cash flow challenges immediately opted to stop investing in flexible investing instruments. On the flip side, all my clients in regular paying plans did not request to stop payment even though insurers offered this option and some of them experienced pay cuts. If you ask me why, I think it's a matter of expectation. When you approach something with zero expectation that it's liquid, you won't entertain thoughts of disrupting your investment behaviour and learn to work around it.
Here's the interesting part. My clients who stopped payment failed to buy the dip and only resumed investing after markets recovered. They started questioning their returns relative to investors who invested through the dip. The difference could be a significant single digit gain compared to a double digit gain. Which really gave them a stark lesson of why buying the dip in a disciplined manner actually goes a long way to contributing to good long term returns.
Here is a quick snapshot that help you understand dollar cost averaging and the impact on continuous investing during downturns.
I like to explain this through this simple example of buying apples. Imagine you spend $10 on apples over a long period and apple prices fluctuate. Let's assume you are unlucky enough to buy apples at its most expensive price and overtime apple prices drop. A consistent $10 purchase would enable you to buy more apples as the price drop. The drawback is that the existing apples you own now are worth less. If you keep up this exercise and as long as the prices of apples are not free falling, your eventual apple stash would be worth more than the total value of what you used to buy the apples even when the apple price never recovered to its original value.
Of course, this is a relatively bleak example. In a more positive example, imagine apple prices become $1.50 instead of $1 on the 12th month. You would have bought 160 apples, and the total stash would be worth $240 while your investment still remains at $120 based on the illustration above. That is a 100% gain in this hypothetical example. Hopefully, this illustration helps you understand why a disciplined approach to investing makes a big difference for longer term wealth accumulation.
Incidentally if you are wondering, most major markets do appreciate over time.
Access to Accredited Investor Funds (AI funds)
Accredited Investor funds are usually reserved for the super rich and is typically not accessible to the retail market. One way to gain access to these funds would be through instruments like 101 ILP where some companies carry these funds. The general expectation is that these funds have the potential for higher returns and more exotic fund management philosophies.
I never really felt it's super important to have access to such funds. However, I've noticed that exclusivity does have a certain demand. Some consumers with sizable surpluses, see investing in such portfolios as a form of diversification that they can't do on their own. Till date, investment results of these AI funds are really pretty decent.
Premium Waivers
Lets assume someone aged 25 is fairly good at investing and this person earns a pretty decent income. Logically, a constant injection of funds into this person's investment portfolio would set the person up for life if he or she keeps up with this till retirement.
However, let's say this person is unfortunate and falls ill with a severe critical illness that impacts his or her ability to work at their job with a similar stress level. As a result of that, a job switch resulted in a 50% pay cut. This person with their savvy investment acumen might have taken up other significant life commitments like a housing purchase and thus have very little disposable income left to plough into their investment portfolio. Hence even with a strong consistent investing track record, a smaller investment fund size basically would result in a smaller retirement fund eventually. Simply put 10% on a $100,000 portfolio is $10,000 while 10% on a $500,000 portfolio is $50,000.
Premium waivers basically pays the premiums for the remaining tenure of the plan when clients falls ill with critical illness. This helps to ensure that goals are still met even when bad health disrupts their ability to retain their income potential. Of course, people who invests on their own can argue that they have bought good term insurance. However, from experience, many people under insure and fail to factor in their investment portfolio when calculating their insurance needs. Above all, when one gets an insurance pay out and face the possibility of loss of income for x period, I'm not sure how much their risk appetite would change given that there's no income coming in and they have uncertainty in healthcare needs.
Summary
This is a fairly long article so I'll sum up everything here.
Do not confuse protection ILPs with investment based ILPs.
Investment based ILPs can still fit into a certain portion of your overall portfolio
Overall cost may be lower compared to similar alternatives if the investment trajectory is long term for professional advice and hand-holding
Additional bonuses helps mitigate costs considerably
Provides a disciplined investing mechanism and make the process less emotional
Provides access to Accredited Investor Funds not usually accessible to retail investors
Some ILPs might provide the option to add premium waivers, protecting the investing intentions even when bad health occurs
Ultimately whether an investment vehicle performs well, it still largely depends on the funds chosen. I would say that instruments like investment ILPs can serve as a good mechanism for people who likes fuss free and a human touch as long as there is proper rebalancing in place.
After reading this article, you may have some questions or may want to get started on your investing journey. You can reach me by dropping me a message.
Be sure to share the article if you feel this information is helpful. You will enable a lot more people to learn about retirement planning.
About Janice
I specialize in portfolio optimization (ensuring you get maximum value for every dollar you put in) and retirement planning.
Clients look for me primarily to outsource their retirement planning needs so that they can focus on other aspects of life that interests them. Many of whom are very good in earning their incomes in their respective professions and wish to ensure their monies continue to work harder while they focus on what they are good at. Refer to client testimonials here. I've helped many clients who are referred to me reduce the costs they are paying for their insurance or help provide solutions when they deem they are stuck with huge commitments bought when they were younger but unsuitable for their present life stages. You can reach me at 94313076 or my social media accounts on Facebook and Instagram.
Disclaimer: The content created are based on my personal opinions and may not be representative to everyone or any organisation. If you have any doubts or queries pertaining to insurance or investment, please seek professional advice from a trusted adviser in an official setting. You may also reach out to me if you do not have a present adviser using the message box under 'Let's Talk'.
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