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The Distinction between Investment & Insurance

In this article we will discuss the distinction between Investment and Insurance and what their ideal roles are in your portfolio.

Insurance and Investing are Separate

A lot of people think insurance and investing are the same. Some people even use these words synonymously. However, there are key distinctions between investment and insurance and they have separate roles to play. In this article, we will discuss insurance & investing, similarities & differences.

What is Insurance?

Insurance is one of the methods of risk management. Insurance is a contract between the insurance company and an individual in which the insurance company agrees to make good a financial loss on the happening of an uncertain event. The individual pays a fee, known as a premium, to the insurance company. Insurance also provides financial protection to businesses from various specified risks.

With insurance, individuals and businesses can transfer financial risks from themselves to the insurance company.

Objectives of Insurance

The primary objective of insurance is to provide financial protection against risks and uncertain events like death, accident, hospitalisation, or damage to an asset. Insurance also encourages people to save money. In addition, the premium collected by the insurance company is invested towards various infrastructure projects for the development of the country. This also helps in generating employment.

Types of Insurance

Insurance is mainly categorised into 3 types: life insurance, health insurance, and general insurance.

  • Life insurance: It provides financial protection to the family in the event of the untimely death of an individual. The most basic form of life insurance is term insurance. In this plan, the life insurance company pays the nominee a specified amount on the death of the life insured during the policy tenure, subject to policy terms and conditions. If the life insured survives the policy tenure, the life insurance company gets to keep the premiums.

Other forms of life insurance plans include endowment, money back, whole life plans. These plans pay a specified amount on the maturity of the policy known as survival benefit. In addition, if the life insured dies during the policy tenure, they pay a specified amount known as a death benefit.

  • Health insurance: It provides financial protection in the event of unexpected hospitalisation due to an illness or accident. An individual health insurance plan covers a single individual, while a family floater plan covers the entire family.
  • General insurance: It provides financial protection to the asset owner in the event of damage to an asset due to an accident or natural calamity. General insurance can be bought for various assets such as a vehicle, home, household items, etc.

Benefits of Insurance

People and society as a whole benefit from insurance plans in a variety of ways. Along with the well-known advantages of insurance, there are a number of others that are less well-known.

1. Provide Protection Against Uncertainty

It is one of the most visible and important aspects of insurance. Underinsurance plans, the insured person or organisation is protected against losses. Purchasing the appropriate insurance policy is a good method to protect yourself from losses caused by a variety of life's uncertainties.

2. Managing Cash Flow

The possibility of having to pay out of pocket for losses has a big influence on cash flow management. You may, however, face this uncertainty with calm if you have insurance coverage on your side. The chosen insurance provider pays in the case of an insured occurrence occurring at any time.

3. Investment Prospects

nit linked insurance plan, invest a part of the premium into several market-linked funds. This allows you to invest money on a regular basis to benefit from market-linked returns while also achieving your life goals.

What is Investing?

Investing is the process of deploying money into various assets to generate returns on them. In simple terms, investing is using money to earn more money. Investing involves preceding current consumption (instant gratification) with the money saved and using it to earn benefits for future consumption (delayed gratification).

Investing involves taking a risk in the expectation of earning a return. Therefore, the higher the risk involved, the higher is the return expected.

Objectives of Investing

Some of the objectives of investing include:

  1. Providing regular income: Some people invest in a particular asset intending to earn a regular income from their monthly expenses. For example, an investor may invest in a fixed income product for monthly interest or in real estate to earn monthly rent.
  2. Capital appreciation in the long run: Most people invest in a securities portfolio intending to generate capital appreciation in the long run to fulfil their financial goals.
  3. Capital protection: Some people invest in a particular asset with the objective of capital protection and liquidity, even if that comes with low returns. For example, an investor may invest his emergency fund money in a liquid fund for capital protection and get immediate access to the money when required.
  4. Financial freedom: For some people achieving financial freedom is a life goal. They invest with that objective in mind. When their investments generate more income than their expenses, they achieve financial freedom, which gives them the freedom to enjoy life.
  5. Tax saving: Some people invest with the objective of tax saving. For example, an investor may invest in an equity-linked savings scheme (ELSS) for tax saving. Ideally, tax-saving should not be the sole objective of investing.

Types of Investment Products

There are various types of investment products. One way of classifying them is based on their type of returns, including regular income, capital appreciation, or both. Some of these include:

  1. Fixed income products can give regular income. For example, a bank fixed deposit with monthly interest pay-out will give regular income in monthly interest. On maturity, the bank will return the principal amount. Thus, there will be no capital appreciation in this transaction.
  • Commodities can give capital appreciation. For example, you invest in gold through a gold mutual fund and hold it. You manage to sell it at a higher price on a future date than you bought it for. Thus, you got capital appreciation. There is no regular income in this transaction.
  • Equities can give regular income as well as capital appreciation. For example, you buy shares of HCL Technologies and hold them for 5 years. During these 5 years, you will get regular income in the form of dividends. HCL Technologies is a profit-making company and pays quarterly dividends. When you sell it after 5 years at a higher price than what you bought it for, you make a capital gain. Thus, you made regular income (dividends) and capital appreciation in this transaction.
  • Real estate can give regular income as well as capital appreciation. For example, you buy a residential property and hold it for 4 years. During these 4 years, you give it on rent and earn a regular monthly income. When you sell it after 4 years at a higher price than what you bought it for, you make a capital gain. Thus, you made regular income (rent) and capital appreciation in this transaction.

Advantages of Investment

If we want to increase our wealth and financial stability, we must invest. The following are some of the more general advantages of investing.

  1. Stay Ahead of Inflation

Inflation is defined as an annual increase in prices and a decrease in the purchasing power of your money. Inflation rates can vary greatly, but historically, inflation has averaged roughly 3%. If we invest our money and, say, achieve a 7% annual rate of return, we will be able to keep ahead of inflation and improve the value of our money.

  1. Long-term Potential for Good Returns

While saving is putting some of today's money away for tomorrow, investing entails putting your money to work in the hopes of earning a higher return over time. Different types of investment assets, such as cash, fixed-income securities, real estate, and stocks, often yield different rates of return (which is relative to the risk of the investment).

  1. Earn Extra Income

It is feasible to supplement income by investing in high-quality assets.

The profit from the assets could be used as a regular source of supplementary income for day-to-day expenses. Alternatively, one might reinvest the funds to increase (or compound) wealth. In the end, it is critical to saving money. Investing can mean having more than just some 'rainy day' cash, depending on your risk level.

Similarities between Insurance and Investing

One of the most considerable similarities between insurance and investing is that both encourage savings. In India, insurance plans (endowment, whole life, money back, etc.) that invest the premiums collected from insured people and provide returns are prevalent.

However, the returns provided by these plans are lower than what pure investment products can provide. Also, the insurance cover provided by these insurance plans is far lower than what a pure life insurance product (term plan) can provide for the same premium. Therefore, these insurance plans neither provide you adequate returns nor adequate insurance cover. Hence, it is best to keep insurance and to invest separately.

Differences between Insurance and Investing

While insurance and investing do have some similarities, the two are distinctly different from each other. To highlight the differences between them, we have considered term insurance plans for insurance as they are the purest form of life insurance. Some of the differences between insurance and investing include:

  1. Objective: One of the significant insurance objectives is to transfer risk from the individual to the insurance company. On the other hand, one of the significant investing objectives is to take a calculated risk and generate returns.
  2. Financial security: Insurance (term plan) is about providing financial security to family members of the insured after his/her death. Investing is about providing financial security to self and family members when the investor is alive.
  3. Returns: Insurance (term plan) does not provide any return on investment. Investments, specifically equity mutual funds, have the potential to provide inflation-beating high returns.
  4. Liquidity: Insurance (term plan) does not provide any liquidity as there is no element of returns in it. Investments can be liquidated once the lock-in period, if any, is over. Some investments also allow loans against them.
  5. Death benefit: Insurance provides a death benefit. The specified sum assured is paid to the nominee in the life insured’s death during the policy tenure, subject to policy terms and conditions. There is no such death benefit in investments. However, on the investor’s death, the nominee can redeem the investments made by the investor during his/her lifetime.

Choosing between Insurance and Investing

There shouldn’t be any choice between insurance and investing. An individual should opt for both, as they have distinct roles to play. During his/her lifetime, the individual should invest as per risk profile and asset allocation to accomplish financial goals. The individual should buy a term life insurance plan as a backup. If he/she dies an untimely death, the insurance plan will provide financial security to the family in his/her absence.

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Q1: What is the insurance policy's waiting period?

A1: The term "waiting period" refers to the time a policyholder must wait before their insurance coverage kicks in. He or she may not be eligible for insurance benefits until the waiting period is over or the insurance coverage begins. In addition, the length of this term varies depending on the type of insurance policy.

Q2: Why do I need to renew my insurance policy?

A2: Insurance policies must be renewed on a regular basis in order for the policyholder to continue to receive benefits. They can be renewed during the grace period after the expiration date, but they may expire if the premium is not paid on time. In addition, the insurance company has the right to refuse coverage for any period in which no premium is paid.

Q3: How is term insurance different from Investment?

A3: Simply expressed, a financial product is purchased with the goal of generating wealth after taking into account the investor's financial objectives, risk tolerance, and expected return. If applicable, one can keep the investment and get periodic returns, as with some fixed-income investments. A pure term insurance plan does not provide any benefits to the policyholder, either during the policy period or after it expires. The death benefit is paid out to the nominees in the case of an untimely death. The goal of insurance isn't to make you wealthy while you're alive, but to save your loved ones from becoming impoverished when you're gone.

Q4: Is it possible for an insurance product to also be an investment product?

A4: Many life insurance policies provide investment opportunities as well. Unit Linked Insurance Plans (ULIPs) allow you to take advantage of the stock market's high return potential, or traditional endowment policies provide assured returns.

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