I remember after graduation, I supported my university friend who joined Prudential to buy my first policy. I believe (in the best of people) that at that time he does not have sufficient financial knowledge to understand the potential pitfalls in some of the policies and that’s the reason why he sold me those policies, not because he wanted to achieve his sales target. He did explain to me the advantages of Investment Link Policy. In the end, I bought an Investment Link Policy and I use my CPF Ordinary Account (OA) to purchase Unit Trust.
Allow me to side track and discuss why you should never utilise your CPF OA to invest in unit trust. Firstly, your OA is generating a return of 2.5% and investing in unit trust, which has upfront sales charge is fighting an uphill battle. I experienced negative return for the 5 years while I was invested. I was down 20% for the unit trust, 2.5% x 5 years will be a 12.5% interest from CPF OA returns which was not acquired, add them up and it was a total loss of 32.5%. Thank God, back then my invested amount from OA account was only about S$7.5k. That’s how I learn that ignorance can be expensive.
Coming back to the purpose of this article, based on the name of Investment Link Policy, it is a product with insurance coverage and investment component. It is suppose to protect the insured while it helps to accumulate wealth while doing so. Is it really the case?
Sales charges range from 3% to 5% of the amount invested. A single premium ILP uses a bid-offer method, units are bought at the higher offer price and sold at lower bid price, the spread is approximately 5%. Fund management fees will be from 0.2% to 2% for an actively managed fund and on top of that, there are wrap fees, surrender fees and mortality charges. Your returns over long term will be deteriorated with all these charges or in technical term call high “Total Expense Ratio”.
ILP is not a cost efficient investment product because you will find difficulty in keeping up with the cost of insurance. As you age, the cost of insurance can be higher than your premium which start to draw down from the funds or accumulated units from your invested portfolio through ILP. This selling off of units to finance your cost of insurance defeats the purpose of investment in the first instance.
Earlier, we mentioned that ILP has high sales charges for investing, how does ILP serve as insurance product? An ILP is not a suitable product for its cost of insurance which increases exponentially with time. If you require insurance coverage, it will be wiser to use term insurance or life insurance. I will not sell something which I will not buy myself, as of time of writing, I will never buy an ILP. If you require insurance coverage beyond 40 years old, ILP will not be economically suitable.
Buying an ILP will require you to keep up with the premiums if you no longer earn an income. When the cost of insurance increases as you aged, the cost will be paid off by selling off your investment units, when the units are depleted, your policy will lapse or you need to top up using additional cash. Either way, it is not a good situation to be in.
In conclusion, to sum up and recap, if you want investment, put your money to buy funds. If you want insurance coverage, just buy term or life plan. Do not mix them together, thinking that you can use the same amount of money and achieve both. There is no free lunch.
I was reviewing my friend’s insurance portfolio and he bought an ILP in 2009 which he held for 10 years already. It will be the only product which I will advise him to cut loss and use the fund to buy term insurance to increase his coverage. I hope that I will always be this way, making sure that my customer/ friend’s interest always come first before mine. Advise them to buy term plan and invest the rest. Coming back to the friend who sold me the ILP and unit trust using my OA, at the time of writing this article, 25th August 2019 will be your 37 birthday, I hereby wish that you are well, I know you are doing very well in all your businesses and hope that you will continue to flourish and value add to your clients.