Indians are known to be more risk-averse than their counterparts abroad. You may not see many Indians taking up extreme sports or trying their luck in the stock market. However, the fact remains that people all over the world are increasingly turning towards riskier options in search of higher returns.
However, even today, an average investor confuses mutual funds with another financial product like Unit-Linked Insurance Plans, better known as ULIPs. Many people purchase ULIPs (Unit Linked Insurance Plans) thinking that they will get the twin benefits of insurance and decent returns. However, when it comes to returns, mutual funds fare much better in the long term and have demonstrated their ability to deliver substantial returns. ULIPs are insurance policies with the dual purpose of providing insurance cover as well as earning you a return by investing. There are certain ULIP products in the market that offer an additional protection element through riders or inbuilt benefits.
However, since ULIPs are underwritten by insurers, the risk profile is different from that of a mutual fund. An insurer, unlike a fund house, is not in the business of managing money. Its objective is to ensure that the sum assured is paid out when the insured person dies, suffers from a disability or meets an accident. Accordingly, the insurer takes a long-term view about investments and tends to look at bonds and fixed deposits over equities. Thus, a ULIP may not be the best product for an aggressive investor. On top of that, ULIPs usually require a larger initial investment, and the premium amounts are periodically reviewed.
Returns wise, both ULIPs and LargeCap Mutual Funds have performed on a similar line. Over a ten-year period, the category average returns of Large Cap Mutual Funds are 12.23% annualised while ULIPs have delivered 11.52%. Hence, there is not much difference in performance, but cost-wise, mutual funds are much better. Returns or IRR of ULIPs are deceiving as the returns or the NAV of ULIPs do not account for the expenses of the plan. In case of Mutual Funds, scheme-related expenses or Fund Management Fees are built in the NAV. In insurance products, it is not inclusive. Instead, it is debited directly from corpus.
ULIPs charge a slew of fees. They include Premium Allocation Charge (up to 12.5% of annual premium), Mortality Charges (depends on your age and sum assured), Fund Management Fees (up to 1.35%), Policy Administration Charges (up to 5% per annum or Rs 500 per month), Fund Switching Charge (Rs 500 per switch), Rider Charge, Alteration Charge (for modifying policy term, sum assured, premium redirection at Rs 500 per transaction), Partial Withdrawal Charge (Rs 500 per transaction) and Service Tax. In comparison, mutual funds charge a graded Total Expense Ratio (TER) which differs across scheme categories, but generally hovers between 1% and 2.25% per annum. The expenses come down as the scheme’s assets under management (AUM) go up.
When you purchase ULIPs, you need to pay the premiums every year and they may increase each year due to inflation or changes in your age. This makes it difficult for some people, especially those who have irregular incomes.
On the other hand, mutual fund schemes are managed by professional managers who study market trends and invest the corpus accordingly. The manager does all the work—from selecting the right stocks to determining how much of the portfolio should be invested in various sectors. As a result, investors do not need to spend time looking at the markets; instead, they can sit back and relax while their corpus grows steadily.
Mutual funds offer regular income through dividends and capital gains from securities held by the fund house. By contrast, the returns from an insurance company are typically linked to the performance of the underlying assets. This means that the returns could vary significantly compared to those from a well-managed mutual fund.
Both mutual funds and ULIPs are regulated by SEBI. This ensures that the investor’s money is safe and earns some interest, while also helping the scheme grow. ULIPs as well as Mutual Fund schemes such as ELSS (Equity Linked Savings Scheme) provide tax benefits under Section 80C.
ULIP essentially is an insurance product. ULIPs have a lock-in period ranging between three to five years, depending on the nature and structure of the investment scheme. Mutual Funds generally have a lock-in period of one year, but in some cases, like ELSS, the lock-in period is three years.
Ideally, one should buy term plan insurance to cover his insurance needs and invest in mutual funds to build a decent corpus. A term plan is much cheaper; it may cost just 0.25% compared to ULIPs that may cost around 4%-6% due to high administrative charge.
While these points may seem important, you should always remember that the decision to invest in either a mutual fund or insurance product depends entirely on the needs of the investor. If you want to make the best use of your money, it is imperative that you take calculated risks. Ideally, you should seek the guidance of a qualified financial professional to make the right investment decision.
(By Abhinav Angirish, Founder, Investonline.in)