Insurance salespeople often try to sell me education and investment policies. Is there any advantage in buying such policies when I can invest in government bonds or save in a Sacco where I am assured of better returns?
Thank you for your question. First and foremost, we all need some insurance in life for protection, either of the assets we have created (asset protection policies such as fire and other perils), protection against loss of life (life policy) and in this instance to reduce the uncertainty around the education financing for your child or children.
While there are insurance policies that promise lump sum payments at maturity, and policies linked to investments, these are additional policies for the primary purpose of insurance. Secondly, not everyone is able to afford a bond, which for a long time required a minimum investment of Sh50,000. Lately you can invest in bonds with as low as Sh3,000 through Mpesa backed M-Akiba program.
A choice between buying an insurance policy and investing in a bond for future school fees is first an issue of whether the person can afford the initial investment required for a bond investment. Where this is not the case, then an education policy would be a first-choice instrument based purely on the ability to afford now, rather than later. Time is a critical enabler in matters involving investments.
More time is required to transform small instalments through compounding returns into a bigger lump sum, therefore there is need to make certain decisions based on the time available rather than on a hope for future growth. Where the individual can afford either an insurance policy or investment in bonds today, the next concern would be which of the instruments offer a rate of return over the period required between purchase and payment of fees.
If the individual needs 12 years to raise a lump sum required for school fees, say Sh2,500,000, both approaches would work but at different rates of return.
An education insurance policy for a similar lump sum will require approximately Sh23,000 per month for 12 years to raise a similar lump sum and offers a guaranteed return of 5 percent compounded without the extra hustle of looking for investment opportunities for interest earned.
Insurance policies assure you of continued growth in policy value once the policy has acquired a surrender value, usually accrued value after about 36 months of continuous premiums payments
Bond investment returns vary with the coupon rate – interest rate operating at the time of issuing. To achieve a Sh2,500,000 lump sum through investing in bonds would require investments of 25,000 in long term bonds at an average coupon rate of about 10 percent for 13 years. You must also plough back the interest earned at the same interest rate or higher. It is noteworthy that each bond will come with a different (coupon rate) interest rate and interest is paid at half the rate, every six months.
Savings in a Sacco work in a similar method to a bond but without the surety of a stable interest rate but interest is paid annually.
The Sacco board declares interest annually based on performance, and when approved by the members in a special general meeting, it is then applied. This increases the risk where the Sacco performance is by matters beyond management control. There is also the additional risk that you could lose your income along the way, which puts to jeopardy such a savings programs efficacy.
It is important to note that these three options for savings, and, or investment, fit different people’s situations. They are not a ‘one jacket fit for all people’s income situations’ kind of solution. The ability to raise a monthly premium is critical in all three scenarios. Work with what suits your financial circumstances.
Patrick Wameyo is a financial literacy coach at Financial Academy & Technologies, and an entrepreneurship coach at the Entrepreneurship Center EA.