Everyone wants to be safe and make the optimum utilization of their funds. However, not every financial instrument is made up of everyone. Financial Advisors always look at the following angles before advising the investment alternative.
- Short term Goal
Tax saving instrument, Interest earning, etc.
- Medium-term Goal
Wealth building instrument, Value Investing, Mutual Funds (dividend option), etc.
- Long Term Goal
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Retirement Planning, Succession Planning, etc.
Each phase of human life needs a peculiar and appropriate investment instrument. Let’s understand how should you choose and opt for the appropriate option of ULIP or Mutual funds.
What are ULIP and Mutual Funds?
ULIP refers to Unit Linked Insurance Premium which is a unique insurance plan, which integrates benefits of both insurance and investment in a single instrument.
In all, it can be said that ULIP is a Hybrid instrument and not a pure insurance policy. ULIP will allow the flexibility to go for wealth building while being under insurance cover.
Mutual Funds refer to the investment pool which is managed by a professional portfolio manager. Any mutual fund would be divided into a number of small units. These units are calculated based on the basis of Mutual Fund’s Net Asset Value.
Difference between ULIP and Mutual Funds
| ULIP | Mutual Funds |
| ULIPs include both the components of Investment Insurance | Mutual Funds are purely an Investment instrument. |
| ULIPs carry a Lock-In period of 5 years. ULIPs can not be fully or partially withdrawn during this Lock-in Period. | Mutual Funds are Liquid Financial Instrument since these can be redeemed or sold in the market at any time. (apart from ELSS which have Lock-in Period of 3 years) |
| ULIP do not display or present their structure of investment on public domains for the general public. This is because ULIPs have a very complex structure hence becomes a little less transparent as compared to Mutual Funds | Mutual Funds carry a simple investment structure which is determined at the inception of Mutual Fund only. Hence, Mutual Funds are much more transparent since the smallest detail about their investment structure are usually hosted on public domain. |
| ULIPS are good for tax management because Investment in ULIP is considered as a deduction from taxable income under section 80CMaturity amount is tax-free under section 10(10D) | Tax impact with respect to Mutual Funds can be summarised as below Investment in Mutual Funds is covered under section 80C only if the same is ELSS (Equity Linked Savings Scheme)Maturity amount / Redemption amount / Amount on sale is taxed as capital gains |
| ULIPs come with several charges like Fund Management Charges, Mortality Charges etc. This will result in a reduction of pure investment corpus which would actually be deployed for return earning purpose. | Mutual funds on the other hands are not burdened with the Mortality charges and also expense ratios are competitive. This results in better-earning prospect even with the impact of exit and entry load |
| ULIP are subject to discontinuance charges when they are redeemed prematurely. This would impact the return. | Mutual funds are subject to only exit load even if withdrawn before the expiry of Lock-in Period. This would not impact the returns already earned during the period of investments. |
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Case Study Analysis for ULIP Vs. Mutual Funds
Let’s take an example of Mr Mehta who is in aged 30 years. He wants to invest in credible and safe investment instrument which will put his funds to optimum utilization. His annual income is Rs.20 lakhs and he is ready to invest Rs.2 lakhs maximum in a year
Mr Mehta is contemplating 2 alternatives for investment; One is ULIP and another is Mutual Funds
A financial advisor has suggested Mr Mehta to invest in ULIP for 20 years which would earn him a decent rate of return and an additional insurance cover. This ULIP is estimated to earn a rate of return around 10-12% since it is market-linked.
In this case, if Mr Mehta thinks that he could allocate the whole of his excess towards the ULIPs. This would result in the following scenarios
- The insurance cover in ULIP is only proportional and usually on the lower side. This would only give him insufficient cover in the long run. Suppose Mr Mehta goes for Rs.50,000/- in a year, it would only give him Insurance cover of Rs. 5,00,000/- in the long run.
- The returns fetched would be first allocated towards charges and the commission so the effective rate of return earned on ULIP would not reach the target rate of return.
- If Mr Mehta wishes to switch or discontinue the ULIP, it would only wipe off the return earned so far and would result in a reduction of the corpus.
It would only make sense if Mr Mehta invests in ULIP at an early age and only a part of his targeted investment amount.
Suppose Mr Mehta wishes to invest in Mutua Funds it will Give him following results
- Mutual fund Investment is directly related to the market and hence the investment would always be subject to market risks.
- However, since the entire investment would be directed towards corpus, it would result in wealth building.
- It will not have any additional insurance cover
- ELSS will have tax benefit as well and would earn a decent rate of earnings
An ideal plan would be as below for Mr Mehta
- Opt for ULIP for 1/4th of his target investment amount which would give him leverage of diversified investment bucket. Suppose he opts for Rs.50,000/- ULIP annually, then it would give him an effective rate of earnings of 10% maximum and insurance cover of Rs.5 lakhs to 7 lakhs. However, this money will be locked in and would be able for withdrawal only after 6-7 years depending upon terms and conditions.
- Choose a mutual fund based on the risk appetite and financial goal. An equity-based mutual fund or Index funds have the lowest Expense ratios. Also, they have the safer potential of earnings since they are directly linked to markets. Mr Mehta in this case can go for the lumpsum investment of almost 50-60% of target investments or through SIP plan.
- Mr Mehta can consult with Insurance Advisor for additional insurance cover which would be sufficient for his age. Ideally, he should choose an insurance cover of almost 10 times of his annual income which would be Rs. 2 crores as his sum insured.
