A few years ago, an old acquaintance messaged me out of nowhere on Facebook. After the obligatory chit-chat and small talk, he made his pitch. He asked me if I wanted to invest in insurance. He proceeded to tell me how buying policy X would earn me a cash value of Y by a certain date, what my projected earnings would be, and so forth.

I told him that while I understood the value of insurance, I didn’t consider it an investment; rather, I considered it an expense. In addition, I told him I didn’t like the idea of mixing insurance with investment. He appeared to take offense to this and started pasting screenshots and dropping success stories about other “investor” clients.

I tried to explain what I meant, but the intensity with which he slammed into defensive mode made it clear that he considered “expense” a bad word. According to him, “expenses” referred to useless things and unnecessary purchases. Buying insurance was planning for my future, therefore it was an investment.  

There was no dissuading him, so we agreed to disagree and moved on.

Now and then I encounter similar language used about insurance, although maybe not with the same level of burning passion. But really, why shouldn’t we think of insurance as an investment?

How does insurance work, anyway?

More than just something that the killer takes out on their spouse at the beginning of a Netflix true crime documentary, insurance is a form of risk management that is used to protect from financial loss. There are different types of insurance, like health insurance, life insurance, and income protection, but at the core of every insurance policy is the same principle: you are paying to protect against something bad.

If the event you have insured against does happen, whether it be illness, loss of income, an accident, or death, your insurer will help cover your loss. Depending on your policy, this may come in the form of them covering your expenses, reimbursing you, paying you a lump sum, or some other form of compensation.

When someone says insurance is an investment, they’re usually referring to one of two things:

• the idea that insurance is an actual  investment, or;
• an insurance product bundled with an investment component.

Both of them are bad ideas. Let’s start with the first.

Insurance is an expense; an investment is an income-generating asset.

Insurance is an expense — an essential one. Expenses are the opposite of an investment. When you invest, you are postponing the spending of money today in the hopes of getting more money tomorrow. Investment means taking a risk, in the pursuit of a possible future gain. On the other hand, when you buy insurance, you are deciding to spend money today, to avoid spending more money tomorrow. Insurance means mitigating risk, by choosing to spend a smaller amount of money today to protect against a possible future loss.

Of course, that doesn’t mean insurance is a waste of money. Insurance can save you money and protect your assets. But thinking of it as an “investment” is wrong from a financial planning perspective. They have different goals and different purposes.

Insurance is like food: you buy it because you need it, not because you hope to earn from it.

Sometimes people refer to insurance as a good investment in a broad sense, in the same spirit that you’d say something like “these shoes were a good investment.” While that’s probably forgivable from a language perspective, in the context of personal finance, it’s wrong.

Let’s take food, for example. Food, which costs money, is essential to sustain life. Buying and eating food allows me to continue living, which in turn allows me to continue to work, generating profit. So you could say that for me, buying food is an investment.

With the same logic, you could call electric bills, eyeglasses, or underwear — pretty much any essential expense — an investment. However, when it comes to financial planning, it’s better to be clear on what an investment is: an asset or item that you buy in the hope that it will generate income someday or increase in value. Insurance is not one of those things.

Labels are helpful; understanding is crucial.

Listing things that aren’t really “investments” under your investment column paints an inaccurate picture of your finances, and will make it harder to make sound decisions. You can’t just decide that you’re going to classify an expense as an investment just to make yourself feel better about it. Adapting to circumstances will often require different adjustments when it comes to expenses and investment, so it’s important to understand which is which.

For example, there may come a time when a drastic reduction in income forces you to put all investing on pause. If you classify insurance as an investment, does that mean that a pause in investing means you let your insurance lapse as well? That would defeat the point of insurance, leaving you unprotected at the worst possible time.

While there are essential expenses, no investment is truly mandatory. We invest according to our goals and capacity. On the other hand, unless you have an emergency fund large enough to weather any storm, you need insurance. Most people cannot afford to be uninsured, because catastrophic events like accidents, illness, or death can happen to anyone.

Thinking of insurance as an investment makes you buy bad insurance products.

How do you gauge the success of an investment? You measure it by the returns that it has generated. An asset that becomes more valuable over time is a good investment. Something that decreases in value over time, on the other hand, is a bad investment.

Judging by that standard, any insurance policy that does not generate a return is a bad investment. Bought health insurance but didn’t get sick? Bad investment. Bought a life insurance policy but didn’t die? Bad investment. The effectiveness of an insurance policy can’t and shouldn’t be measured with the same yardstick, because it doesn’t fall in the same category. We invest in things we believe in, as opposed to insuring against things we fear may happen. When we confuse the two, we may end up making bad decisions, like buying bad or ill-suited insurance products or buying insurance for the wrong reasons.

Buying Protection vs. Seeking a Return

To help illustrate this, let’s look at term life insurance, the simplest form of life insurance, usually the cheapest and most cost-efficient type of life insurance. You pay a premium that insures you for a particular term. If you die during the term, your beneficiaries receive the assured sum. If not, in terms of monetary return, you receive nothing. But that shouldn’t be a problem, because you got what you paid for: protection during the life of the policy. You aren’t buying an asset or an investment, you are buying protection. This purchase of protection is an expense.

A misplaced investment mindset leads insurance buyers to ask the question: “what do I get out of this if I don’t die?” People have a hard time swallowing the idea of “lost” term life premiums paid. If a policy doesn’t pay out, they make the mistake of considering the money they paid into the policy wasted. No one likes the idea of losing money.

So, in an attempt to squeeze some semblance of a financial return out of life insurance (without dying), they opt for much more expensive types of life insurance policies, like whole life insurance, even when they don’t need them. People love the idea of getting their money back, so people feel that they are “investing” because these policies build up a paltry cash value over time. However, these policies are usually much, much more expensive than term life insurance. 

Others choose more complicated plans that include an investment component, like variable universal life insurance (VULs). These are very popular because they are marketed as being “investment-oriented.” Unfortunately, simply tacking an investment feature onto an insurance product doesn’t magically change the nature of insurance; it just makes it more complicated. A lot of people misunderstand these policies, thinking that they’re building a nest egg when all they’re doing is making their insurers and their agents rich; the commissions on these can be huge.

These policies are more attractive to the investment-seeker because they offer “something” back, like a fund value that can be withdrawn or borrowed against at any time, or a lump sum that you receive when the policy matures at a future date. 

If you had bought the equivalent term life insurance and invested the difference (commonly referred to as BTID) instead, you would have gotten the same coverage, but a bigger return on your investment. Trying to hit two birds flying in opposite directions with the same stone doesn’t help you, it just slows you down.

Don’t buy insurance if you’re looking to get something back. Remember, we insure against our fears, against the things that we never want to happen. Whenever you buy an insurance policy, you should be hoping that it never pays out.

Use the right tool for the job.

If your goal is to grow your wealth, invest. Invest in assets that generate revenue or increase in value. Buy mutual funds, stocks, or real estate. Start a business. Investing puts your money to work, protects you from inflation, and builds wealth.

If your goal is to prepare for life’s surprises, buy insurance. Protect future earnings, save yourself from unexpected medical expenses, and make sure your dependents are going to be taken care of no matter what happens.

Don’t waste time and money hammering in nails with a screwdriver. Insurance and investment are two of the most important tools available when it comes to building and protecting wealth. A sound financial strategy involves both, appreciates the difference, and uses the right tool at the right time, every step of the way.