The following is my answer to a Quora question: “Why do insurance salespeople pitch life insurance as an investment?”
Whole life insurance is not an investment. A fully paid-up policy may function as a financial instrument, or as a form of leverage, but that does not make it an investment. A way that high net worth policies are financial instruments is when the client buys the policy with premium financing. Such policies are single-premium plans, not regular premium. This means that there is a minimal payment from the client, and the rest is paid for by the bank. The client then pays back the rest of the premium in instalments, at low interest. For example, if the premium is $100,000 for $10 million coverage, and the minimum down payment from the policy owner is 20%, the client has paid $20,000 upfront for that $10 million coverage. The rest of the premium is covered by the financing bank, and the client then pays the bank back in instalments.
This policy is now considered fully paid up, and may be borrowed against, should that need arise. That client, if he has a relationship with the bank, may then take out a credit line that is, for example, 1.1 times the policy value. In this case, that would mean a credit line of $11 million. This means, in effect, the client has paid $20,000 to create liquidity worth $11 million. This does not work for every single whole life plan. This is a simplistic illustration to illustrate the point. Finance works differently when you have money. Wealth grants you access to options not available to the masses.
The primary purpose of diversification is to mitigate exposure to any one section of the economy and spread the risk. It is about risk management, and not growth. It is not the key to good investment. It is a hedge against loss. The key to a good investment is relative to your investment horizon. A good investment needs to have sound fundamentals on the underlying asset. This is especially important for leverage products, and wrappers.
It is true, however, that sound diversification allows you to take advantage of growth in other areas when you are experiencing a loss of value in commensurate asset classes. For example, bonds and debt instruments tend to rise when stocks and equity fall, and vice versa.
Diversification also affords you some flexibility since some asset classes are more liquid than others, and have a ready secondary market. This allows you some flexibility when managing your portfolio. You may also diversify across risk categories, which allow to take advantage of growth, yet mitigate losses in a general downturn.
The following is my answer to a Quora question: “What are sukuk bonds? How do they work, and how are they Islamic?”
Sukuk is not, despite its name, a bond. A bond is a fixed-income security, a debt instrument for the sole purpose of raising capital. They are a loan agreement, between the bond issuer, and the creditors, the investors, where the bond issuer is obligated to pay a specified amount of money at specific dates.
Sukuk is an financial certificate, that is created to comply with an interpretation of shari’ah. They circumvent the general prohibition against debt security, and concerns of usury. In this case, the issue sells investors a certificate, using the proceeds to purchase the asset, whereby the investors have partial ownership. Here, we have debt that is not a debt. Capital is still raised. The issuer is contractually obliged to buy back the certificate at par value, at a future date.
While the bond has a yield, the holders of a sukuk certificate receive profits generated by the underlying asset. This is because the sukuk certificate is actually a certificate of ownership of the underlying asset. If the underlying asset appreciates, the sukuk certificate appreciates. If it depreciates, then we have to consider the terms of issue. Thus, the valuation of the sukuk certificate is calculated on the value of the backing assets, while bonds prices are determined by its credit rating, and demand on the secondary market.
If you are investing in unit trusts (or mutual funds) or Investment-linked Policies (ILP), you would notice the terms “Consumer Staples” and “Consumer Discretionary” under Sector allocations when reading the fund factsheet.
What are Consumer Staples?
Consumer staples are essential products that include typical products such as foods & beverage, household goods, and hygiene products; but the category also includes such items as alcohol and tobacco. These goods are those products that people are unable—or unwilling—to cut out of their budgets regardless of their financial situation.
Consumer discretionary is a term for classifying goods and services that are considered non-essential by consumers, but desirable if their available income is sufficient to purchase them. Examples of consumer discretionary products can include durable goods, high-end apparel, entertainment, leisure activities, and automobiles.
Consumer Staples are essentials that we will buy regardless of how the economy is doing
Consumer Discretionary are items or services we would only buy when the economy is well and we can afford to spend
How does knowing this influence your investment decision?
If you are an investor who seeks stability and lower risk, you would consider a fund that has a strong allocation in Consumer Staples, as you can be assured the fund would do reasonably well despite the economic situation.
If you are an investor who would take risks, you are likely to have less allocation in Consumer Staples and more in Consumer Discretionary. Yet, you would also evaluate if it is a good time to have a strong allocation in Consumer Discretionary, especially in the current pandemic where:
Entertainments like cinema are running at less than 10% of normal operations
Integrated resorts have been badly hit the past few months. Yet, on the other hand, there are campaigns to encourage local tourism.
Malls selling high-end apparels are seeing low footfall, yet some are slashing prices to encourage buying.
These are some factors to consider before getting into Consumer Discretionary. Many mutual funds/unit trusts would have an allocation in Consumer Discretionary, though the percentage allocation would vary.
It seems I have become a magnet for people enquiring on being pushed or mid-sold insurance products, occasionally getting such enquiries.
So I thought perhaps I should write some pointers for customers out there:
1. Savings plans may not be for you
Savings plans, though seemingly safe, may not be for you.
“But savings is good for you, for future needs.”
Yes, it is good.
“Plus, there’s no investment risk..”
Yes, it would seem so. So where does the problem lie?
Premium commitment. Often, customers are led to sign up a 20-year or 25-year plan. (Can you commit that long?)
Inability to withdraw when needed. While it is a strength to discipline yourself to save regularly, it is also a weakness. (Is liquidity a concern for you, especially for the next 5 to 10 years?)
High cost of early surrender. Life can be uncertain. Your commitment to the plan can be affected. (Will you be able to sustain the plan or flexibility to adjust is an important consideration? Is liquidity, again, a concern?)
I will continue in 2 or 3 subsequent posts touching on the other types of insurance products that can be mis-sold or pushed to the customers to buy.
It could look something like: SGD-H. This means that the fund’s underlying exposure is hedged to the SGD. When you buy a unit trust with a SGD-hedged share class, you are in effect hedging your exposure (from the fund’s underlying exposure) to the SGD. The fund you purchase may be invested in the European credit markets, whereby securities there are denominated in the EUR. Thus, your currency risk as a Singapore-based investor would be to the EUR, and the value of your investment would be exposed to the fluctuations of the EURSGD exchange rate. By adopting a SGD-hedged class of the fund, you can lower your risk of a weakening of the EUR against the SGD eroding your investment returns from the European credit market.
For Singaporean investors, a SGD-hedged fund allows you to invest in a fund that is denominated in another currency, while lowering your risk of the currency weakening.
Should you invest in such a fund? It depends on your objective, your risk appetite and other preferences and considerations. It is best to discuss with your financial planner/advisor before choosing such a fund.
The following is my answer to a Quora question: “How can life insurance pay out more than the person has put in?”
From an individual perspective, the insurer has paid out more than the premium if the claim was early. From the insurer’s perspective, they have paid out one claim for a single policy, but have earned from tens, even hundreds, of thousands of other policies that are still premium paying. This is the benefit of portfolio costing. Also, when insurers take in all that premium from their policyholders, they invest it out for further returns so that in the event of a spike in claims, the insurer is not financially compromised.
The following is my answer to a Quora question: “Should you add international bonds to your portfolio?”
That really depends. Bonds are used to balance out a portfolio, diversify it and spread risk. When it comes to international bonds, particularly long-term bonds, you have to consider currency and political risk. You can mitigate the latter by putting your funds in rated investment grade sovereign bonds or corporate papers. It is difficult to mitigate against the former. For example, consider how it is from my perspective in Singapore. 20 years ago, the US Dollar to Singapore Dollar was US$1 to S$1.60. Today, it is US$1 to S$1.30. I am old enough to remember a time when it was close to US$1 to S$2. If I put my money in a 30-year Treasury bond, what would I expect the exchange rate to be in 30 years’ time? Would I earn enough to overcome that exchange rate exposure? These are major considerations in how I balance my portfolio.
It is an advantage as well as a disadvantage that international bonds are not correlated to the domestic bond market. It means that a drop in the local bond market does not necessarily mean a drop in my international bond portfolio, which balances it out. But it also means that a domestic rally would not be a rally across all my debt instrument portfolio. International bonds are an excellent way to diversify your portfolio, and mitigate from local political risk. But they should be one component of a balanced, diversified portfolio, not a major part of it.
Finding a balance and diversified portfolio is usually achieved through experience and diligent study of the market.
One might come across financial planners/consultants who would favour certain funds which seemingly painted as good, such as giving high dividends. Yet the graph on the fund factsheet would indicate otherwise.
It is always important to remember the objective of the investment, and a good financial planner/consultant should advise you towards that objective.
He should be able to make a decisive call, such as when his previous fund recommendation is not performing as expected, and hence recommending fund switch or premium allocation redirection with justification.
The following is my answer to a Quora question: “Which of the following is best hedge against inflation? Land, investment, real estate, precious metals, or a mutual fund invested heavily in large capital stock market?”
The best hedge against inflation is property and REITS. The price of homes and property rise with inflation because their prices are also affected directly by inflation. REITS will grow due to the increase in value of the underlying asset.
Gold, commodities and precious metals tend to be a good hedge against inflation, but only as a broad basket of investments. Individual commodities may not perform as well. Gold is also an excellent hedge against political risk.
Debt and equity instruments are poor hedges against inflation. Equity instruments such as stock will rise eventually because that is the market trend, but in the short term, may not keep up with the sudden increase in inflation. Debt instruments, which include sovereign bonds are terrible hedges against inflation since the yield is fixed over the term. They are used to balance a portfolio, not hedge against inflation.
The following is my answer to a Quora question: “Do high yield bonds have a high default rate during a recession?”
Yes. These bonds have a lower credit rating, meaning they are not investment grade bonds. These bonds are not rated corporate papers, or sovereign bonds. Their underlying issuer either has a weak financial position, or is already heavily leveraged. To attract investors, they have to offer a higher yield. Most such bonds are essentially junk bonds. Let alone a recession, a high yield bond from a start-up might default simply because that start-up missed a fund-raising target. These are not debt instruments for the faint-hearted, or those with liquidity exposure.