Is Paying for Insurance a Gamble? Your Biases Could Hurt Your Finances

 Some people may feel that paying for insurance and gambling are similar because in both cases, a person sets aside a smaller amount of money in the hope of getting a disproportionately larger return. Let’s look at the 3 behavioural biases in gambling psychology which could affect your insurance planning – framing effect, loss aversion and optimism bias.

1. Framing effect

The most significant bias experienced by us is that of the framing effect of insurance pay-outs. In gambling, the benefit is the immediate gain of the money wagered. One can immediately experience the joy of winning.

Insurance, on the contrary, has benefits which are not easily foreseen. Is it an asset or a liability? Why should I be paying money to cover an event that I do not wish would happen? Decision making behind insurance purchases is in direct conflict with many of our common product purchases. Would I buy a computer and not use it? This bias is stronger towards insurance due to its benefits being intangible. When a product is too complex, we tend to procrastinate decision-making and thus, insurance is often neglected among our priorities.

2. Loss Aversion

Humans are highly loss averse.  We have a stronger tendency to avoid losses than to acquire gains. Empirical estimates that from a gambling perspective, the pain of losing $100 is at least twice the joy of gaining $100. So, if people are more loss averse, does that mean people are more likely to buy life insurance? The purpose of insurance is to protect us and our family against huge financial losses from catastrophic events right?

Unfortunately, the thought process of a consumer on the street is even simpler than that and the following video is indeed a cause for concern.

A probable reason for this finding would be that people view paying insurance premiums as a guaranteed loss, while the insured event is just a possible loss. When one is faced with a small guaranteed loss versus a larger possible loss, as behavioural studies suggest, many will choose to take a gamble and NOT buy any/sufficient insurance. Many people risk having their savings wiped out and find themselves severely lacking in insurance coverage ONLY when disaster strikes.

3. Optimism Bias

This is a well-established bias that causes someone to believe that they are less at risk of experiencing a negative event compared to others. Will a gambler walk into a casino thinking he is going to lose money? The answer is almost definitely no as we are often filled with high hopes of making a profit.

On hindsight however, many gamblers will feel that they should not have started gambling in the first place. Unfortunately, this realization usually comes only after one has suffered a significant loss. Optimism bias always leads one to overestimate the chances of winning and underestimate the risks of losing.

The same logic applies for insurance. Most people feel they will certainly live a healthy and accident-free life. (Honestly, who doesn’t?) Sadly, life is as predictable as the September 11 attacks and we can’t use a crystal ball to find out what happens tomorrow.

Insurance planning is an integral part of one’s financial plan. In the event of a thunderstorm, only those who carry an umbrella can be sheltered. People who don’t have an umbrella end up drenched. A well-planned insurance portfolio is the exact opposite of a gamble. Without sufficient coverage, we are gambling with the financial future of ourselves and our loved ones. Given the little insurance planning most Singaporeans have, many people may be “gambling” without realizing it.


How is “Safe” Actually Dangerous? And Vice Versa…

Some people may feel that investing in equity markets is dangerous. This is true when you do it for the short term and focus on a single country market. However, if you have a globally diversified portfolio and are able to invest for the long term, you will be able to enhance your returns with a low level of risk.

Here’s a simple question – Do you think the world’s economy will be larger 20 years from now than it is today? More likely than not, the answer is yes. The world’s population will be larger in 20 years, which will lead to more people using/wanting goods and services provided by companies. With an increase in overall demand, companies will be producing more and generating more profits. With greater profits, stock prices and stock markets will rise. The MSCI World stock market index shown below reflects how our economy grows with time.

Credit: Wikipedia
Credit: Wikipedia

Population growth is not the only driver. Human beings are also always demanding a better standard of living. For example in Singapore, we “upgrade” from a HDB flat to a condominium; we drive a small car and “upgrade” to a larger one. As markets like China, Thailand and even Vietnam open up and grow economically, their people will have higher incomes. They will start with demanding basic consumer goods and as their incomes grow, they will want to buy more and better products.

You may ask – If I put all my money in Thailand today, can I expect a definite profit in 20 years’ time? That is harder to predict although there are many good reasons to believe that Thailand will continue to grow. Many countries have faced extended periods of decline before (e.g. Japan in the 1990s). This is why you need to have a well-diversified portfolio across different regions and countries around the globe.

Our annual inflation rates in Singapore for the past 3 years have been fluctuating from 1.5% to 5.4%. This is precisely why it is risky to leave your money in “safer” instruments such as fixed deposits (often yields below 2% annually), because it might be worth less than the amount you would have to pay for your daily needs over time.

Everyone should know the difference between gambling and investing. A trip to casino can be fun but approach stock market in the same way and you will find yourself in trouble. Like a turbulent flight, volatility is uncomfortable and it is easy for anyone to bail out at the first wobble. However, if you are currently in your 20s or 30s, youth is the single huge advantage for you to ride out the ups and downs in the long term. Successful investing requires one to embrace volatility, not fear it.

But if you keep your money in fixed deposits or other “safe” instruments, you do not know if the returns will keep pace with inflation over the long term and that will be a real danger.

3 Mistakes in Retirement Planning

retirementIt is common for young working adults to delay saving for retirement as they feel that they still have a long time before this stage in life.

Suppose you are 25 years old now and intend to retire at age 65. Given the average life expectancy of Singaporeans of 85 years old, you would have about 40 years to accumulate wealth and live the remaining 20 years without a working income.

Among the younger Singaporean parents now, most are only having 1 or 2 children. Due to the fact that the standard of living will increase in future, it is getting harder for our children to survive and take care of us when we turn old. It is not sensible to depend on our government too. Hence, the best way is to prepare now on our own, so that we can enjoy our old age without worries. Here are 3 mistakes you should avoid when planning for your retirement:

1. Saving too little

saving too little

Many people save around $100-200 per month. This is not sufficient if we want to retire at 65, and live a decent lifestyle (eg. travel once a year and eat out once a week). If you save $200/month at 6% growth per year, you would only have $400,000 in 40 years’ time. Naturally, if you intend to retire earlier at say 55, you have less number of years to save and need to thus save more.

2. Starting too late

When we are in our 20s, we save for marriage and our first house. In our 30s, we save for our children’s education. It is only when our children are much older, we begin to start saving for retirement. By this time, we are likely to be in 50s. Even if we begin at 40s, to meet our financial goal, we may need to turn to investments with higher yield. By not managing these higher risk investments properly, we may even lose our savings.

3. Playing it too safe or too risky

If we keep our money in the bank, the low interests paid are grossly insufficient to help us beat inflation. Hence, the purchasing power of your money is actually shrinking. On the other hand, if you do not know how to invest and just plunge into the stock market, you are likely to lose a lot of money. Depending on their risk appetite, there are different forms of investments which are suitable for each individual. The 3 most common forms in Singapore are shown in the following table:

Holding period Investment (low to high risk) Expected returns Risk of Loss
1 year Fixed deposit 1% Very low
5-10 years Bonds 3-5% Very low
17-25 years Stocks 7-15% Very low

For these 3 types of investments, the risk of loss can be minimised with their respective holding period. The riskier the investment, the longer the holding period required, and naturally you can expect higher returns. For younger people, there is an advantage with stocks because they have a longer time horizon to invest before retirement. Hence, it is also important for you to know which stage of life you are at, understand your purpose of saving & investing and select a product which fits your risk appetite.

At age 25, retirement may seem to be something so much later in future. But the later you start saving for it, the greater the amount you need to save. As an article from Lifehack suggests, one of the top 10 regrets (Point 8 in article) in life among people who are about to die is not saving more for retirement. Remember the saying, “You are the young person that can take care of yourself at old age”.

4 Smart Steps to Financial Freedom

Financial freedom is defined as the state of not having to work actively and be able to sustain a desirable lifestyle. You will have the ability to make choices, to spend time with your family and loved ones, to travel the world or to pursue a lifelong interest which you haven’t been able to. All these can be done without worrying about money. Read on to find out what are some steps which you can take in your pursuit of financial freedom.

1. Create a budget


If you are earning an average annual income of $50,000, in 35 working years you will earn a total of $1.75 million in today’s dollars. If inflation averages 3%, this becomes $3 million. But how much are you likely to save? Some people may say, “If I earn more in future than what I get now, I will be fine.” But in reality, this is easier said than done.

Whether we earn $2,000 per month or $20,000 per month, we ALL have a problem with saving money. The more we earn, the more we tend to spend. People who have worked for at least a few years can testify to that. Some fresh graduates earn about $3,000 per month. Three years into the workforce, some of them draw as much as $5,000 to $6,000 per month. Guess what? They feel poorer than they first started out. This is naturally so when you have multiple credit card bills, a car loan to service, a family to support, gym membership fees and many other expenses.

Therefore, it is wise to do a monthly cash flow budget, so that you know where your money goes. It is perhaps the first step to finding the extra dollars for saving and investment.

2. Protect your family and yourself

Our government consistently sets aside 20% of national budget on defence. Without a doubt, protection is of utmost importance. Isn’t it only appropriate that we allocate 5% to 10% of our income to defend against untoward circumstances?

Once you have set aside an emergency fund of 3 to 6 months of your living expenses, you should get down to taking care of your protection needs. This essentially means insuring You, because You are your greatest asset. We should be buying as little insurance as you need. But for most people, these protection needs are quite a lot.

3. Live well below your means


Being frugal is the fundamental of wealth building. Yet, too often, we have the false impression that all millionaires lead an extravagant lifestyle, which is exactly opposite from the truth! People whom I talk to who are financially carefree are usually living well below their income. They still pamper themselves with the occasional indulgence and frequent holidays. But trust me, these people do their sums.

You should always discuss with your spouse on both your spending habits and hopefully arrive at a consensus. A couple cannot accumulate wealth if one of them is a spendthrift. Few can sustain lavish habits and simultaneously build wealth. Singaporeans generally build wealth by keeping a tight budget and controlling their expenses.

Remember, “The lower your lifestyle, the greater your true wealth”. How so? Say A earns $50,000 a year, spends $20,000 in a year and has $200,000 in saving. B earns $300,000 a year and spends $250,000 in a year and has $1.5m in saving. A is wealthier than B because if both of them lose their income, A can survive for 10 years based on his saving of $200,000 whereas B can only live for 6 years. Wealth is the duration your savings can last based on the lifestyle you are used to if you stop work now.

4. Don’t plan to save cash

Look at your monthly budget. You should have $600 left over every month and save $7,200 a year but where is the money? From my experience, Singaporean can’t save cash, or they simply save only to spend it all later. These folks faithfully put aside $600 every month, only to wipe it all off with a long December holiday. Some prefer to splurge on furniture and electronic gadgets, others on cars and home renovations. The money disappears naturally.

A typical Singaporean worker’s mindset is “I work so hard so I need to spend money to pamper myself.” Notice the logic, work hard and spend hard, work harder and spend harder. The only solution to this vicious cycle is to ensure that you have some form of disciplined and regular savings to help you set aside a certain percentage of your income every month.

Some practical tips are listed below:

  • Get yourself started in a profit participating insurance policy, variable life policy or “Buy Term and Invest the Difference”. Just get started on “something” and see it through!
  • Be persistent in setting aside at least 10-15% of your income every month; never waiver in this.
  • Immediately invest or allocate any unexpected windfall you receive, like a bigger than usual bonus. Chuck it away before you spend it away.