Putting things in perspective, both of them can be used to save for long-term financial goals but the choice between the two will depend primarily on the investor’s profile and investing behaviour.
As far as re-introducing long term capital gains tax (LTCG) on equity shares and equity mutual funds (MF) is concerned, the Budget 2018 will be remembered for long. Without going into the merits and demerit of the government’s LTCG tax move or its implication on long-term investing, let us delve into the mist it has created for retail investors. It has re-ignited the debate on whether mutual fund has lost its tax advantage to unit linked insurance plan (Ulip). Putting things in perspective, both of them can be used to save for long-term financial goals but the choice between the two will depend primarily on the investor’s profile and investing behaviour. Taxation is only one part of the whole story when it comes to choosing between two products. It’s an important deciding factor, but a tax advantage or a disadvantage shouldn’t be the pivotal point to decide on a savings vehicle.
How investment products work
Selection of investment products hinges on several factors, including the way one understands how the investment products work, one’s own understanding of the financial concepts, etc. A case in point: a chemical engineer who may still be comfortable with numbers and market terminology and its working while it may not come naturally to someone working even in a bank.
For someone who is comfortable with financial concepts, understands how different asset class functions and other related investment concepts, it may be better off to build the investment portfolio through mutual funds rather than choose a Ulip. The open-end equity mutual funds come with no lock-in period and are simple, transparent and a flexible option for generating high inflation adjusted returns over the long term.
But, this virtue at times may prove to be a spanner in the wheel to long-term investing. Unless one has properly planned for various short, medium to long term goals, the probability to dip into MF kitty becomes high. It is no surprise therefore that holding period for MF investors have been falling. According to industry data, at the beginning of 2015-16, 44% of equity assets stayed invested for more than two years. However, as the market sentiment turned bearish, these have dipped to 37%. Had they remained invested, the returns would have been considerably higher for them in 2018.
Mutual funds vs Ulips
Mutual funds suit those who have financial discipline and knowhow about the market movements. The lack of disciplined investment habits may spoil the objective of saving for the long-term goal. If mutual funds suits you, build a core portfolio comprising 2-3 diversified large cap funds and top it up with 1-2 mid-cap funds. That brings us to the case of Ulips to see who could be more suited to invest in them. Those who lack financial discipline and are not naturally inclined towards financial concepts, etc., are more suited to invest through Ulip. While MFs are much simpler products, Ulip is a complex hybrid investment that has several charges and mortality to take care of.
Ulips, which have a lock-in period of five years, are perceived to carry ‘high charges’, while in reality the regulator has capped the charges, barring the mortality charge. Another important feature in Ulip that often goes overlooked is how long should a policyholder keep paying premium? Unlike in the past, new Ulips don’t have the feature of ‘premium holiday’. So, invest in Ulip only if you are willing to run it till the original term by paying premium each year. This not only keeps the average cost of owning a Ulip low but also inculcates the savings habit. Ulips offer features such as life stage investing which helps to automatically manage allocation across assets as per one’s age. While taxation and costs are important in selecting products, equally important is how well one is able to manage investments on one’s own. It is therefore important to evaluate oneself and see whether MF or Ulip is more suitable before signing on the dotted line.
The writer is VC & MD, Bajaj Capital