Why â€œBuy Term, Invest the Differenceâ€ Seldom Works
You may have heard the common expression when it comes to buying life insurance: â€œBuy term, invest the difference.â€ But should you live by it? The expression is an attempt to solve the age-old struggle between buying whole or term life insurance. One of the benefits of a whole life policy is that it will build cash value over the years that can be borrowed against. This means that in addition to a permanent death benefit, your policy builds additional money over time, usually starting after the second of third year of the life of the policy. The total cash value rarely grows to a significant amount (not usually more than a few thousand dollars). Opponents of whole life have called this benefit insignificant and have completely thrown out whole life as an option. Thus the alternative is born: â€œBy term, invest the difference.â€ This advice instructs consumers to purchase a term life policy (which typically has lower premiums than a whole life) and use the extra cash not spent on premium to invest in something that will offer a greater return than a whole life policy. Sounds pretty good, right? Here are two big reasons to think twice before acting on this advice:
- People never stick with it. A consumer might pay the first few months of premium and put the extra money in a savings account while it accumulates. What the consumer is really doing is putting their money in a â€œput-and-take.â€ A put-and-take is something that almost everybody has: a savings account, a safe, piggy bank, secret vault, etc. Something they put money in, but take money out when the car needs a new transmission; when a credit card bill is suddenly overdue, when a son or daughter needs books for college. A put-and-take will seldom accumulate to an amount useful for investing.
- The word â€œtermâ€ in term life insurance means that at some point that policy is going to terminate, usually after ten, twenty or thirty years. That means you have paid a few decades worth of premium, and when the term is up and you are still alive you are back to square one with no life insurance. Only this time you are older, probably less healthy, and any life insurance policy you try to buy at that point is going to be much more expensive than when you bought your term policy.