How Being Financially Literate Can Help You Better Prepare For Future Events

How Being Financially Literate Can Help You Better Prepare For Future Events.  While at the bank, I saw a pamphlet from an insurance company advertising their product to help you prepare for your child's tuition.  So in this post, I'm comparing the returns of their plan with what you can get if you invest the money instead.
While at the bank, I saw a pamphlet from an insurance company advertising their products to help you prepare for your child's tuition, having savings, and getting insurance.

My attention was immediately focused on the one for tuition. I'd rather not mention the company since this is neither an advertorial nor an exercise in disparaging them.

I'd just like to point out how being financially literate can help you prepare better for future events.

Their best offer (i.e. the one most likely to actually meet exorbitant college tuition) is "Plan 4500".

Essentially you pay Php4,500 per month for 5 years (Years 1-5). And on year 10 you can get a 60,240 annual benefit.

Bonus: you can pay 50,000 annually (instead of 4,500 monthly) for the plan, to achieve the same result and save yourself 4,000 per year.

Another bonus: the annual benefit increases yearly, all the way to Year 17 - which will give you 74,626 annually.

And it also has a cash "gift" - though it's unclear if that is already factored into the quoted returns, is not guaranteed, or is subject to some other condition, and there's also no mention of how much it is. So I'm assuming it's already quoted, since they would probably want to quote the total returns to entice customers.

So let's do some digging:

If you pay 50,000 annually for 5 years, that's 200,000 250,000 pesos in total costs. (thanks to Richard Magallanes for pointing out my math mess-up)

However 60,240 per year of college education (typically 4 years) is 240,960. A loss. But lets assume they meant for a 5-year course; that's 301,200.

That's a total gain of ~20.48% after 5 years (on the assumption the "fund" doesn't grow until you've completed payment).

Sounds nice right, 20.48%? But, with five yeas to grow, that's just a yearly compounded interest of 3.7966% per year.

Usually, that kind of yield (and higher) can be made in a time deposit or government bonds.

With today's low interest rates though, you'd have to take more risk to get something like that - stocks, forex, gold (or other commodities), or maybe bonds that aren't so "safe" and have a higher yield (possibly corporate bonds or government bonds of less financially sound countries).

For the common retail investor, the next investment after bonds and money market (Time Deposits, SDAs, etc.) are usually equity funds (either via mutual fund or UITF)

How much do those equity funds return? Well, if you cost-averaged over five years, like the example in my previous post, you can get returns of 158% to 209% - and that was assuming you redeemed near the bottom of a bear run (instead of the fairy-tale scenario of redeeming at the peak).

So you're Php250,000, instead of just getting 301,200, could yield you a total of 645,000 - or more than quadrupling the total gain of what the product promises (395,000 vs . 51,200)

The results are even more lopsided once we compare with Year17's 74,626 annual benefit. Your equity fund would have had 12 years to rack up gains, far outstripping the ~5.1333% compounded annual growth rate of the plan.

Php74,626 over five years is Php373,130. But you're equity fund, assuming tepid returns of just 7% annually (well below the ~10% annual returns usually quoted for equity funds), would give you Php429,546.5 - or 15% more, even for this lackluster investment result. 

Of course, the main selling point of the plan is that the returns are guaranteed.

But 5 years isn't such a short time for equity funds. Come to think of it, even balanced funds over 5 years should yield better gains.

And where do you think these insurance companies invest the money anyway? Well, they could have bought some government bonds on their own, a higher-yielding kind not available to retail investors.

But even so, for a five year holding period - robbing you of liquidity, perhaps even opportunity cost, - you have enough time buffer to mitigate risks and chase higher gains.


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photo credit: lumaxart via photopin cc

4 comments:

  1. This is exactly why my FAMI-SALEF account is denominated as the bub's education fund. The collapse of the pre-need companies really turned me off from educational plans, and even if they're already regulated by the Insurance Commission, I'd rather take my chances with equity funds since the yield will always be way higher.

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    1. Yeah, the old pre-need plans - which guaranteed the tuition fee, no matter how high - was too good to be true. Nowadays, the education plans - if you find one - have too low yields.

      So I'm banking on equity funds too.

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  2. if you pay 50,000 annually for 5 years, that's 200,000 pesos in total costs.

    wrong calculation. it should be 250,000.

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    Replies
    1. whoops! my bad, you're right it should be 250,000. My initial computations were all for four years, until I realized the company was asking payment for five years. I corrected the numbers. thanks for point it out.

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