Updated: Aug 28
Yesterday we gathered in our very own Chai Tapri on the outskirts of the town to have some tea & snacks. It is very normal that once we attain our early 20s whenever there is a get-together we talk about business and what to do with our future. So with the first cup of tea began the discussion and one of my friends "Karan, who owns a general store" told me that he recently bought a Life Insurance plan. Let me share with you the specifics of the plan, which he described in detail. This plan involves quarterly premium payments of ₹15,000 over a span of 20 years. At the end of each 5-year interval, he stands to receive ₹1,50,000, a cycle that repeats until the culmination of the 20th year. Furthermore, a lump sum of ₹17,00,000 awaits him after the 25th year. In conjunction with these benefits, the plan includes insurance coverage of ₹12,00,000 for the entire 25-year policy duration. The strategy he envisaged for utilizing the inflow of ₹1.5 lakhs every 5 years involves investing it in a Fixed Deposit. Interestingly, 'Karan' mentioned an alternate policy that offers a unique proposition. In this scenario, refraining from withdrawing ₹1,50,000 at the end of every 5-year interval triggers a potential repayment of ₹35,00,000 at the end of the 25th year. This raises questions about the strategic implications of withdrawal decisions.
As soon as I reached home I immediately reached out to my friend, Piyush, to collaborate on deciphering the intricacies of this plan...Upon collaborative analysis, Piyush and I unearthed substantial disparities in the potential returns and benefits between the LIC Life Insurance plan. Plan A, involves a cash inflow of 1.5 lakhs, and Plan B involves refraining from withdrawing ₹1,50,000 at the end of every 5-year.
Below I have attached an analysis of Plan A:
*For calculation purposes, I have considered a @7% rate for FD.
*We have considered @12% pa. rate to calculate FV.
**The reason for INR 11,250 instead of 15,000 will become clear after further reading.
before you read further, I would like you to go through the analysis that I have attached for your reference.
Plan B involves a scenario where no withdrawals of 1.5 lakhs are made within every 5-year period. Consequently, the entire amount remains invested, leveraging an annual compounding rate of 12%. This strategy ensures the sustained growth of the invested funds over time.
**Now, let's delve into why we're opting for 11,250 INR instead of 15,000 INR. An integral part of Karan's strategy is integrating an encompassing insurance policy. To achieve this, I've collaborated with Ditto Insurance to unearth an insurance plan that offers extensive coverage at a significantly lower premium. This meticulous approach ensures that Karan continues to maintain his 15,000 INR budget seamlessly. As a result, the surplus sum of 3,750 INR is efficiently allocated towards fortifying his insurance coverage.
*Declaration: This blog does not contain any sponsorship from Ditto Insurance.
Conclusion: Exploring the Optimal Path
In our meticulous analysis, a fascinating revelation emerged as we delved into the financial intricacies surrounding Karan's potential choices. Should he opt for Plan A over his current insurance policy, a remarkable transformation awaits. His investment's future value is projected to reach a substantial ₹31,98,558, eclipsing the ₹17,00,000 that the insurance company would offer. Notably, this calculation excludes the future value of his Fixed Deposit (FD), which stands at ₹14,99,762, assuming a growth rate of 7%.
However, the intrigue deepens further when we consider Karan's decision to embrace Plan B in lieu of his existing policy. By resisting the urge to withdraw ₹1,50,000 at the conclusion of each 5-year cycle, Karan unlocks a potential future value of an impressive ₹60,92,048. This stands in stark contrast to the insurance company's pledged sum of ₹35,00,000.
Adding a compelling twist to the narrative, both Plan A and Plan B come with an insurance policy that boasts not only significantly reduced premiums but also an extensive cover of ₹1 crore, a vast enhancement compared to the initial coverage of ₹12,00,000.
In this intricate financial landscape, the allure of these two plans shines brightly. Plan A's consistent growth, bolstered by its periodic cash flows, promises substantial returns that outpace Karan's current policy. On the other hand, Plan B's strategic restraint could potentially yield even higher rewards, paving the way for a future that surpasses his initial expectations.
As the financial horizon expands, Karan is presented with a dual opportunity for transformation — a path where prudent decisions align with financial goals. The choice between Plan A and Plan B hinges on his appetite for risk, the pursuit of maximized returns, and the desire for comprehensive coverage. In this dynamic scenario, it's the interplay of numbers, strategy, and informed decision-making that shape the trajectory of Karan's financial future.
A Key Consideration: Fluctuating Interest Rates
It's important to note that our analysis is underpinned by a projected interest rate of 12% per annum. While this rate may vary and exert an influence on the future value, our assessment remains robust. In light of this, regardless of potential interest rate fluctuations, both Plan A and Plan B appear to outsmart the previously discussed insurance policy.
Learnings & Lessons:
After presenting the calculations, my friend was shocked because he thought it was an excellent deal. However, he was, in fact, heading down the path of financial ruin. When I inquired about what led him to believe it was such a favorable deal, he mentioned the allure of receiving 17 lakhs with a 6 lakh investment. Upon questioning him about the insurance aspect, he replied that the insurance was merely an additional benefit that made the deal even more appealing to him.
My dear friends, Karan's situation imparts a crucial lesson. Firstly, he overlooked the application of the "Time Value of Money". Secondly, it is unwise to conflate insurance with investment. Thirdly, not everything that glitters is gold.
Stay tuned as we explore the intricacies of this financial decision in our blog.
A heartfelt shoutout to my friend Piyush for his invaluable role in unraveling the scenario's complexities. Gratitude for the insightful collaboration!
Until next Time,
The Humane Opportunist.
I hope you have read and understood the above discussion. Imagine yourself as Karan's financial advisor. What would you recommend to him?