Do you think of insurance as an investment? Here’s why that’s a bad idea

Posted by on May 13, 2013

edited overloaded donkey

Do you think about insurance the same way you think about your investments?  If so, that's a problem. You might be overloading your insurance with unreasonable expectations (like the poor donkey in the photo above).  A major cause of misunderstanding is consumers' tendency to view insurance as an investment rather than a protective measure. It's worth thinking about the distinction between them, which can lead to smarter financial decisions.

Investment vs. insurance: what's the difference?

Here's a handy table summarizing the main differences:

Insurance-vs-investment-PolicyGenius

Ok, investments are different from insurance:  so what?

So what #1:  Don't expect a "return" on your insurance dollar.  For example, if you buy flood or disability insurance, don't abandon those policies because it's been a few years and you haven't used them yet.  No losses does not make insurance a "bad investment."  Count yourself lucky that you haven't experienced a flood or disability.  You bought the policies to protect yourself from losses from those possible events - not to get rich on claims.  Say it out loud:  the best return on insurance is no return.

So what #2: Be suspicious of products that promise a return on your insurance dollar.  And here we're mostly talking about cash value life insurance (whole, permanent, universal and variable all fall into this bucket).  You may have seen other personal finance experts talk about why these products are a bad idea (see Dave Ramsey and a passionate Suze Orman below).

Cash value life insurance basically promises an investment return on part of your premiums (in a cash value that builds up on your policy) and a traditional death benefit.  These cash value policies are much more expensive than traditional term life policies and provide a return (net of commissions and expenses) that is less than the long-term return you could get on the market.  Most people are almost always better off buying inexpensive & simple term life insurance and investing the rest of your cash in pure investment vehicles (like your 401(k) or IRA).

Just remember that insurance plays a narrow, specific role in your financial safety net: it's there if you need it. You don't plan to use it (tomorrow I'm going to have a car accident!) It's not like your cash savings or your retirement assets, which you do plan to use in the future. Keep this in mind and you'll make much better financial decisions.

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