This article first appeared on fundMyLife, the platform that connects you to the right advisers.
Usually presented as a form of forced savings plans for certain financial goals, endowment can take on several roles be it for savings, insurance, and even a mixture of both. Undoubtedly, given its many facets, it is not surprising that there are plenty of misconceptions about endowment plans.
Say endowment plans to anyone, and chances are that you might see the person shudder. After all, endowments are commonly sold by relationship managers in banks and financial advisers – the plan has gained quite a bit of notoriety. That said, we here at fundMyLife believe that each financial product serves a particular purpose.
Earlier on, we asked a few of advisers of fundMyLife about their opinion on endowment plans and from their stories we observed that there were several consistent misconceptions that consumers have regarding these plans. As such, in this article, we highlight these common misconceptions about endowment plan that people have.
# 1 Endowment Plans Are Not Liquid
Contrary to what a (possibly) errant adviser or relationship manager in a bank might tell you, endowment plans are not liquid, i.e., you cannot back out in between premium payments and you’re locked in for the stipulated time period in the plan. According to our research, this is a surprisingly common misconception about endowment plans.
While it is a good way to enforce savings for a particular financial goal, the mandatory monthly payments may become a major source of stress when you are unable to make payment due to unforeseen circumstances. As such, it is important to recogne this fact early and consider what’s the best place for your money.
#2 Guaranteed Value Does Not Always Mean You Make More Money
In the Benefits Illustration of the plan generated for you by your financial adviser, there are several columns that require your attention.
Source: HardwareZone Forums
With reference to the table above, there are a lot of numbers, but the most important parts are highlighted in the following table.
Arrows drawn to show the guaranteed death benefit (black) and guaranteed returns (red). Source: HardwareZone Forums
Assuming the plan matures in 15 years, the guaranteed amount upon maturity is still less than the basic premiums paid. Thus, it is useful to compare the guaranteed portion of the plan vs the premium paid to see how much you lose in the worst case scenario. In the ultimate worst case scenario where there are no non-guaranteed returns at all (quite unlikely), you might lose quite a bit of the principal that you paid.
Therefore, it is always important to update your Benefit Illustration from time to time so that you know your endowment plan is on the right track.
P.S. If you haven’t noticed, for a lot of Benefit Illustrations, you can see that the column for death benefit will always come first because the value is always higher than the premium paid. Your eyes will always land on the higher value first, before going to the lower value. We don’t know if it is intentional, but it’s good to train your eye and tear it away to look at the surrender/maturity value.
#3 Projected Returns Do Not Equate To Your Actual Returns
This brings us to the next point about returns. Even if the fund performs at the stipulated level and reaches the projected returns, what you are getting will always be less than advertised. That is because when the fund achieves either 3.25% and 4.75% returns on their investment, it’s the fund that achieves that returns and not your plan. Hence the careful wording: “projected returns of investment”.
#4 Flexibility May Not Be The Best Thing
And that brings us to this point on flexibility and returns. In a bid to make endowments more attractive, insurance companies introduced plans with payouts. It is a welcome feature since the payouts can either be reinvested or be used for other things. However, is the flexibility truly a good thing? Let’s have the math do the talking. We came across an excellent table from Talk Money Lah illustrating the difference in the internal rate of returns between reinvesting cashback and withdrawing the cashback (the rest of the article is pretty awesome as well).
Source: Talk Money Lah
Upon closer calculation, having payouts at regular intervals give you lower returns when the plan matures. Even with the same amount of principal, the internal rate of returns can be different at the end of the policy term. You can see that there is a trade-off between flexibility and returns upon maturity.
In our earlier piece, the financial advisers of fundMyLife opined that if liquidity is an issue, you can either do either
- A fixed endowment but at a lower amount of premium, or to
- Split the money into both endowment and something safe like Singapore Savings Bond
#5 Endowments Are Not Worse Than Investments
At the risk of sounding cliched, comparing endowments to investments is the same as comparing apples to oranges. Both are separate asset classes with different levels of risk and structure. Furthermore, both are used for different purposes.
One good thing about endowments is that having guaranteed returns means even at the worst of times you would still have a sum of money, as opposed to investing where your money could potentially vanish if the stock market goes awry.
Furthermore, the timed component of endowment plans also means you can plan years ahead, something which stocks won’t be able to 100% guarantee.
Endowments instil discipline for those who might otherwise not save for their financial goals. You just have to figure out which plan is the right one for you at your particular life-stage. More so, guided by a trusted financial adviser.