The Insurance Fallacy

Buying insurance feels responsible. Buying it as an investment feels clever. But for millions of investors, this mix often backfires, leaving them underprotected and underwhelmed by returns. It’s time to stop taking the wrong steps and take control of your financial future [EasyDNNnews:PaidContentStart]

For decades, Indian households have been told a comforting story. Buy this insurance policy, pay a fixed premium every year, stay disciplined, and at the end of 15 or 20 years you will receive a lump sum that will take care of your future. Protection and wealth creation bundled neatly into one product. It sounds sensible, safe and familiar. No wonder millions of salaried individuals, first-time earners and even seasoned savers continue to follow this path. The problem is that this story rarely plays out the way investors imagine. 

In trying to make insurance do the job of an investment, many Indians end up with two outcomes they never planned for. Inadequate financial protection when life takes an unexpected turn, and disappointing long-term returns that struggle to beat inflation. This confusion between insurance and investment objectives is perhaps the most widespread and costly personal finance mistake in the country. This story aims to help readers clearly separate the roles of insurance and investments, understand why traditional insurance products fail as wealth creators, and adopt a simple but powerful framework: protect first, invest second. 

Two Different Needs, Two Different Tools
Let us begin with a basic but often ignored truth. Insurance and investment solve two completely different financial needs. Insurance exists to protect your family from financial shock. It steps in when income stops due to death, illness or accident, or when medical expenses threaten to derail hard-earned savings. The goal is risk protection. Returns are not the priority. Expecting insurance to create wealth is like using a safety helmet to win a race. It may keep you protected, but it was never designed to help you move faster. 

Investments exist to grow wealth over time. They help you beat inflation, meet long-term goals and build financial independence. The goal is compounding. Risk is accepted and managed, not eliminated. Trying to combine these two objectives into a single product usually weakens both. Think of it like using a screwdriver to hammer a nail. It may work occasionally, but it is inefficient and damaging. You would never build a house that way. Yet, many investors build their financial lives on this exact compromise. 

Why Traditional Insurance Products Remain Popular
Here’s an important question. If insurance and investment are meant to address entirely different financial needs, why do traditional insurance products continue to find favour with investors? The answer lies in persistent buying behaviour. Despite years of investor awareness campaigns, products such as endowment plans, money-back policies and whole-life covers continue to account for a significant share of new insurance sales in India. There are several reasons for this. First, they appeal to emotion. The promise of guaranteed money at maturity feels safe. The word insurance itself creates a sense of responsibility and discipline. 

Second, they are aggressively sold. Agents often position these policies as Tax-saving investments, retirement solutions or even children’s education plans. The focus is rarely on protection. Third, they fit a familiar savings mindset. Many Indians are more comfortable with fixed deposits and assured returns than market-linked volatility. Traditional insurance plays into this comfort zone. Unfortunately, comfort does not always translate into financial efficiency. To understand this gap between intent and outcome, let us look at a few practical, real-world examples. 

The Hidden Cost of Mixing Insurance and Investment
Most endowment and money-back policies deliver annualised returns of around 4 to 6 per cent over long periods. This is before adjusting for inflation. If inflation averages 5 to 6 per cent over the same period, real returns are close to zero or even negative. Your money grows on paper, but its purchasing power barely improves. Now compare this with long-term equity Mutual Funds, which have historically delivered 10 to 12 per cent annualised returns over full market cycles. 

Even after accounting for volatility, taxes and periods of underperformance, the gap is significant. The difference between 6 per cent and 12 per cent may not sound dramatic in a single year. Over 20 or 25 years, it changes everything. Consider a 32-year-old salaried professional earning ₹12 lakh a year. On the advice of an agent, he buys a traditional endowment policy with an annual premium of ₹1 lakh for 20 years. The policy promises a maturity value of around ₹40 lakh and a life cover of ₹25 lakh. 

At first glance, it appears sensible. There is forced saving, tax benefit and insurance rolled into one product. What remains unseen is the opportunity cost. Over two decades, the investor pays ₹20 lakh in premiums. The eventual maturity value translates into an annualised return of about 5 per cent. After adjusting for inflation, the real return is negligible. Meanwhile, the life cover of ₹25 lakh is barely two years of income replacement, leaving the family financially exposed if something were to happen during the policy term. 

Now consider an alternative approach. The same investor buys a pure term insurance plan of ₹1.5 crore at an annual cost of ₹18,000. The remaining ₹82,000 is invested every year in equity mutual funds through a systematic investment plan. Even with a conservative long-term return assumption of 10 per cent, this investment alone can grow to over ₹55 lakh in 20 years. The contrast is striking. In the first case, the investor ends up with low protection and modest wealth. 

In the second, he secures meaningful financial protection while building a significantly larger corpus. The difference does not arise from higher risk-taking, but from using the right financial tools for the right objectives. This is the hidden cost of mixing insurance and investment. It is not just about earning lower returns. It is about unknowingly compromising financial security while believing one is doing everything right. 

To create a like-to-like comparison, the cost of a pure term insurance plan must be explicitly accounted for when evaluating the investment led approach. Even after setting aside the annual term insurance premium, which is typically a small fraction of the total outgo, the investment option remains far superior. For a 32-year-old, a ₹1.5 crore term cover can be secured for under ₹20,000 a year. 

Deducting this amount from the annual investment reduces the investible surplus marginally but does not materially alter long-term outcomes. The equity investment continues to compound at a significantly higher rate while the investor simultaneously enjoys substantially higher life cover. This adjustment confirms that the wealth gap between bundled insurance products and the insurance plus investment strategy is not due to ignoring protection costs but persists even after fully accounting for them. 

Inadequate Protection Is the Bigger Risk
Low returns in case of bundled products are only half the problem. The more dangerous consequence of mixing insurance with investment is inadequate financial protection, a risk that often goes unnoticed for years. Many policyholders assume they are well insured simply because they pay a large premium every year. The size of the premium creates a false sense of security. What truly matters, however, is the amount of life cover, not how much is paid to maintain the policy. 

In reality, the life cover provided by most traditional insurance policies is alarmingly low when measured against income and responsibilities. Consider a 35-year-old salaried professional earning ₹15 lakh a year, with household expenses, loans and long-term family goals. Financial planners typically recommend life insurance cover of at least 10 to 15 times annual income, which works out to around ₹1.5 to 2 crore in this case. 

Yet, an endowment policy with an annual premium of ₹1.2 lakh may offer a life cover of just ₹20 to 25 lakh. This amount would replace income for barely a couple of years, leaving the family vulnerable just when financial stability is most critical. The policyholder believes they have achieved both savings and protection. In reality, they have compromised on both, ending up with insufficient cover and inefficient wealth creation. 

Common Mistakes to Avoid
Despite growing awareness and easy access to financial information, several avoidable mistakes continue to show up in everyday financial planning. Recognising these errors early can make a meaningful difference to long-term outcomes. A common misstep is buying multiple traditional insurance policies over the years, each positioned as a solution for a different goal. One policy is sold for tax saving, another for a child’s future, and yet another for retirement. 

Instead of creating a structured plan, this approach leads to scattered coverage, overlapping commitments and modest returns that fail to meet any goal efficiently. Another frequent mistake is continuing old insurance policies without periodic review. Many investors keep paying premiums simply because they have already paid for several years. This reluctance to reassess often results in money being locked into low-yield products even when better, more suitable options are available. 

Investors also tend to underestimate their life insurance needs. High premiums create a misleading sense of adequate protection, while the actual life cover remains insufficient. Some investors stay away from mutual funds altogether, fearing market volatility, while overlooking the silent but certain risk of inflation eroding low-return savings. These mistakes stem not from poor judgement, but from a lack of financial clarity. 

What Investors Should Do Instead

• Term Insurance: High Cover, Low Cost
  The most effective solution to life insurance needs is also the simplest - term insurance. A pure term plan provides a high life cover at a very low cost. There is no maturity benefit, no savings component and no confusion about purpose. If the policyholder dies during the term, the nominee receives the sum assured. If not, the policy expires. 

For the same 35-year-old professional, a ₹2 crore term plan may cost between ₹15,000 and ₹20,000 annually, depending on age and health. Compare this with the ₹1.2 lakh premium of a traditional policy offering a fraction of the cover. Term insurance does one job, and it does it well. It protects income and ensures financial stability for dependents. Once this protection is in place, the remaining savings can be invested more efficiently. 

• Health Insurance is not a Choice
  Alongside life insurance, health cover is another pillar of financial protection that is often underestimated. Medical inflation in India runs well above general inflation, often in the range of 10 to 12 per cent. A single hospitalisation can wipe out years of savings if one relies only on employer-provided cover or small individual policies. Health insurance is not an investment. There is no return to calculate. 

Its value lies in preserving your investments by preventing forced withdrawals during medical emergencies. Adequate health cover should include a base policy and, where possible, a super top-up. This combination offers higher coverage at a reasonable cost. Again, the objective is protection, not returns. 

• Mutual Funds: Designed for Wealth Creation
  Once protection needs are addressed, the focus can shift entirely to wealth creation. This is where mutual funds play a critical role. Mutual funds offer diversification, professional management and access to market-linked growth across asset classes. Equity Funds, in particular, are well suited for long-term goals such as retirement, children’s education and wealth accumulation. 

Unlike traditional insurance products, mutual funds are transparent. Returns are market-linked. Costs are clearly disclosed. Investors can track performance, switch funds and rebalance portfolios as goals evolve. Equally important, mutual funds encourage goal-based investing. Each investment can be aligned to a specific objective, time horizon and risk profile. This clarity is impossible to achieve when insurance and investment are bundled together. 

Protect First, Invest Second
Fixing the insurance versus investment confusion does not require complex financial engineering or sophisticated products. What it demands is clarity of purpose and the discipline to apply a simple framework consistently. At the heart of sound financial planning lies a straightforward principle: protect first, invest second. The first step is to assess protection needs objectively. Life insurance cover should be calculated based on income, outstanding liabilities and the financial needs of dependents. 

For most earning individuals, this means buying an adequate term insurance plan that replaces income if something were to go wrong. Alongside this, health insurance coverage must be reviewed carefully. Rising medical costs make comprehensive health cover essential to prevent savings from being derailed by unforeseen expenses. The second step is to draw a clear line between insurance and investment. Insurance premiums should be treated as a cost for financial protection, not as a savings instrument or a wealth-creation tool. 

Expecting insurance products to deliver strong long-term returns only leads to disappointment and compromises financial security. Once protection is firmly in place, the focus can shift to investing. This third step involves building a diversified portfolio aligned with financial goals and time horizons. Equity mutual funds can drive long-term growth; Debt Funds can provide stability and liquidity, and other asset classes can be added based on individual risk appetite and objectives. Each investment should have a clear role in the overall plan. 

The final step is regular review. Incomes change, responsibilities evolve and markets move. Financial plans must adapt accordingly, without emotional attachment to specific products. This framework may sound obvious, but its impact lies in consistent application. At its core, personal finance is about control over risks, cash flows and outcomes. Separating insurance from investments restores that control, bringing clarity, resilience and a stronger foundation for long-term financial freedom. What are your views on this approach? Are you already following it, or do you plan to adopt it now? Write to us and share your experience. 

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