We all have a tendency to over-invest in insurance. We simply assume that somehow having someone else promise us a bail-out we can go ahead and stop worrying.
But as AIG’s 61.7 billion dollar loss and it’s reasons covered in NYT show, lots of people bought Credit Default Swaps from AIG assuming that if the companies or Securities defaulted they would be able to cover their ass. Now the only thing that is keeping these people afloat is the forbearance of the US Treasury.
A similar pattern also emerges if we look at individuals. Most buy too much insurance, starting from 3 year warranties on computers to buying insurance on car wind shields. We over-consume insurance by trying to shift the risk, but the real issue is uncertainty in aspects of our life.
A better approach instead of buying insurance would be to create emergency savings which you put aside at the beginning of the year and use it as and when the need arises. When your laptop crashes, when your mobile phone gets stolen or you just have a rough year.
The great thing about this approach is that unlike insurance premiums you can roll this over if there was no need in a particular year.
The Emergency Fund can be broken into the following proportions
- 30% in gold (mostly 10g coins as they are easy to carry)
- 30% in 3 month rolling FDs
- 20% in a Bank Current Account
- 10% in Blue Chip Stocks
- 10% in Cash in Hand
Roughly about 10% of the value of the electronics and household goods should be enough.