A financial plan can be divided into two major categories; protection products and accumulation products. This division is not arbitrary. The two categories serve different roles, but they also complement each other. Protection products are designed to shield individuals against loss while accumulation products seek to accumulate wealth and increase capital through savings and investment.
The basic logic of financial planning is that relevant protection products be employed before one focuses on accumulation products. Protection products include emergency funds, various types of insurance and estate-transfer vehicles like a will. The key to protection products is the various insurance plans since they indemnify the insured. Insurance products are critical to financial planning because they do all of the following:
1) Decrease your financial risk- By providing income that is not yet earned, protection products deepen your reserves. In the event of unexpected or catastrophic financial losses, protection products can fully cover or subsidise the cost to an individual.
2) Protect your assets or net worth- If you have enough in reserve or adequate coverage you would not have to liquidate assets in order to receive cash to cover expenses. In the case of general insurance, particularly homeowners insurance, the coverage will insure that you are returned to your financial standing after unexpected loss or damage.
3) Protection products increase your standard of living- With protection products you have the privilege of having more disposable income since you do not have to keep an unnecessarily high amount of savings in reserve. Attempting to self-insure means that you must save an extremely high percentage of your salary in order to build a fantastic emergency fund. Doing the opposite means that you can enjoy more of what you earn.
4) Protection products facilitate taking more risks with accumulation products- A prime rule when investing is to not invest more than you could afford to lose. If you have your full complement of protection products in the background, you could afford to lose more without being vulnerable to the risks that you are insured against. You could feel at ease investing in long-term, capital appreciating investment vehicles because you know that you would not need to liquidate them in an act of financial desperation.
Insurance products in financial planning should be extended to include the general insurance category. The most important thing about employing protection products adequately in a financial plan is that it can provide you with peace of mind. There is not a price that one can attach to that feeling. If I had an object insured, I would certainly worry less about losing it or having it stolen. The same principle extends to important assets and your health and well being. Realise that the most important asset that you can cover is your life, health and well-being for yourself and your loved ones as well. Understanding the role of protection products would help you to realise that they are not expenses but enablers.