The Pros and Cons of buying a life insurance

Most people are more familiar with the pros, 

i. Your family get a sum if you accidentally die prematurely or

ii. You get a sum when you faced terminally ill deceases or critical deceases

iii. It can be used by rich to transfer wealth in countries levy inheritance taxes

Etc Etc. 

Few people are familiar with the cons, 

i. Basically for some, they never recoup back the premium they paid to be insured against the risk

ii. It is not an efficient form of investment, especially for life insurance came with an investment plan, there always be a clause stating that, actual investment return depending on the fund managers performance.

iii. If you can keep paying the premium, you keep enjoying the benefit. But once you failed to make payment once, you forgo everything you accumulate in the past. 

iv. It literally follow the contract wording when came to decide the payout. And, most of the people who buy the life insurance, actually don't know the difference between type of diseases cover, or structure of payments. 

Last but a few, 

i. In malaysia where no inheritance taxes are levied, it matters less if you can used the life insurance to transfer the wealth. (although we do have tax exemption for life insurance, the amount exempted is combined with EPF contribution, which means when EPF contributions exceed RM6,000 per year, you receive no tax exemption for amount pay for life insurance.)

ii. If your family don't need you to leave a bequest, then you have no need to buy a life insurance. 

iii. Some big corporations do provide group life insurance, you can check whether you need to go for beyond. 

Writing one Investment Policy Statement (First Trial)

The Investment Policy Statement (IPS) , define one return and risk objective, while listing down all the relevant constraints (time horizon, taxation, liquidity requirement, legal, and other unique requirement). This will subsequently determine what portfolio can be invested into in the Strategic Asset Allocation (SAA).

Few assumptions:

i. Malaysia Inflation Rate to be 2.5% per year. (last 10 years average, 2.38% see calculation here.)

ii. Salary to be rise at 5% per year. 

iii. required living expense per month to live comfortably = RM 2,000 in current ringgit. 

iv. Malaysia income tax rate unchanged. 

v. EPF average return to be 5% per year. 

vi. Life expectancy to be 85 years. 

vii. Will retire at 60 years, as current statutory minimum retirement age. 

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The first thing to know, is to calculate how much you need to sustain the living standard for 25 years after retirement.

This can be done by summing the Present Value (PV) of all future expense at age 60. 

I figure i would need RM 4631 per month starting age 60 for minimum standard of living (equivalent to RM 2000 that current ringgit value and 2.5% inflation rate). 

This translate to RM 55568 for the first year, and total PV of next 25 years expense to be RM 1.05 million (assuming constant rate of return of 5% in EPF) 

Ie, i would need to have RM 1.05 million by the age of 60 to ensure enough saving for retirement. 

I figure if my current salary to keep rising at 5% per year and EPF rate of return to be 5% per year, i would have roughly RM2.2 million by age of 60. Which means, except regular EPF contribution, i do not need to save anything now from my current salary. 

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Hence my IPS will be

Return Objective : after tax 5% per year (nominal) 

Risk Objective: 

Ability to take risk - High ( as i am currently still young , with stable income to sustain living）

Willingness to take risk - High

Constraints: 

Time Horizon - Long (more than 15 years)

Tax consideration - as Malaysia dont tax capital gain nor dividend income, there is less concern here. 

Liquidity requirement - Not applicable for the moment. ( or one month expense to sustain living until next salary banked in)

Legal - Not applicable for the moment. 

Unique requirement - Not applicable for the moment. 

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Things will get complicated when I need to save for marriage, save for first home, save for emergency medical fund when i get old, save for some desires in my life etc. This will be address later when i subsequently revised my IPS and setting saving goals. 

calculating Inflation Rate for Malaysia

First, the inflation rate can be calculated from consumer price index as,
Inflation rate for year 2000 = consumer price index at year 2000/consumer price index at year 1999.

Time series data for Malaysia Consumer Price Index can be obtain for free at malaysia department of statistic website here.

The results is in the table below.

Few implications,

i. Inflation rate usually rise when economy is booming, fall when economy is in recession.
ii. Average inflation for past 10 years (2.38%) is lower than 32 years average (2.98%), suggesting a slowing down of inflation as economy expanding in the age of globalization.
iii. when inflation rate is at 2.38% average,
Real interest rate = nominal interest rate - inflation rate stood at below 1%.
Keeping money in fixed deposit or buying government bond for long term is not a particular good choice.