ULIPs VS Mutual Funds
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ULIPs VS Mutual Funds
When it comes to investment, it is often two
products that are discussed the most Unit Linked Insurance Plan (ULIP) and
mutual fund. Many a times investors tend to compare these investment products
due to apparent similarities. The longstanding debate between investor and
advisors is which one is better?
What is ULIP?
A life insurance product, ULIP provides risk
cover for the policyholder along with investment options to invest in any
number of qualified investments such as stocks, bonds or mutual funds. As a
single integrated plan, the investment part and the protection part can be
managed according to specific needs and choices.
A part of the premium paid goes towards providing
the policyholder insurance cover, and the other is invested in stocks and bonds
for wealth appreciation. A policyholder has the freedom to choose. Mr
Sharma being risk averse will choose to have his money invested in bonds, while
Mr. Menon with a greater appetite for risk could opt to invest in equities.
What is Mutual Fund?
A collective investment scheme, mutual fund is a
term most commonly applied to open-end investment companies where many
investors invest their money in the fund to form a pool. A fund manager then
invests the collective fund in stocks, bonds, and other asset classes.
From time to time, the mutual fund distributes
dividend to its investors. Mr Sharma chooses to reinvest these dividends back
into the scheme and will get a lump sum at the time of exit.
What are the similarities?
Both ULIPs and mutual funds carry a certain
element of risk in them that arise from investing. The risk may be lower in
case of debt investment and higher in case of equity investment. While debt
investments face the risk of defaults and changes in interest rates, equity
investments face the risk of market volatility and the fund manager’s skills.
In terms of structure and functioning, ULIP as an
investment avenue compares well with mutual funds. Just like mutual funds, the
insurance company allots units to its ULIP investors and a net asset value
(NAV) is declared on a regular basis. Along with that, ULIPs have the liberty
to invest across assets just like mutual funds.
What are the differences?
ULIP’s biggest benefit is that it combines the
features of both insurance cover and investment opportunities under a single
plan. And that is the key difference between ULIP and mutual funds. While
mutual funds are pure investment products, ULIPs provide cover and
investments.
But that is not all that sets them apart.
Evaluating the two avenues and see how they measure up
Parameters to differentiate
1. Ease of investment
With a systematic investment plan (SIP),
investors can start investing in a mutual fund with as little as Rs 500 a month
for a short duration, such as 12 months. An investor can discontinue a SIP
midway without any penalty or financial implications and with the investment
intact.
ULIPs on the other hand are more structured. An
insurance advisor will assess the investor’s income and financial
responsibilities, then draw up an investment plan to pay a fixed premium for a
minimum of five years, which Mr. Sharma is very comfortable with. However,
there is a financial implication if an investor wants to exit the ULIP before
the minimum investment tenure.
2. Expenses
With some exceptions where Insurance Regulatory
and Development Authority (IRDA)prescribe limits, the insurance company
determines most expenses. The most expensive part about ULIPs is the high
premium allocation charge usually not exceeding 10% of premium. Then there are
mortality charges, fund management charges, policy administration charges among
others.
With mutual funds, expenses are lower. Securities
and Exchange Board of India (SEBI) sets the upper limits for expenses
chargeable to investors. Expenses charged by mutual funds to investors for a
range of activities like fund management, sales and marketing, administration
are subject to certain limits. For example, equity-oriented funds can charge
investors a maximum of 2.25% per annum for all expenses; if it exceeds the
limit, the expenses will be borne by the fund house instead of investors.
From a purely expense perspective, mutual funds
seem more cost-effective. ULIPs may be more expensive than mutual funds in the
initial years. But Mr. Sharma knows that ULIP being a long-term product, this
cost is spread over a longer period and hence, becomes similar to the cost of
investing in mutual funds.
3. Liquidity
If an investor needs investment to be easily
convertible into cash on short notice, then it is better to opt for a mutual
fund. Mutual funds are more liquid since it is more widely traded in the
market. ULIPs have a lock-in period of minimum five years. This works for
long-term investors like Mr. Sharma who are less likely to be in a hurry to
redeem their money. During this time, you cannot redeem your money. But not all
mutual funds are liquid. Equity Linked Savings Scheme (ELSS) funds also have a
three-year lock-in period.
4. Portfolio disclosure
Mutual funds, as per SEBI guidelines, are expected
to disclose their portfolios on a quarterly basis, although most disclose them
monthly as best practices. This gives investors a chance to study their
portfolio and figure out where and how their money is working for them.
ULIPs are also required to disclose their
portfolios on a quarterly basis and like mutual funds many choose to do so
monthly for greater transparency.
5. Flexibility in asset allocation
Since Mr. Sharma chooses to have the benefit of
insurance cover with his investment, ULIPs give him the flexibility to choose
the amount to be used for insurance cover and what goes towards investment.
Changes in asset allocation are either free or at a nominal cost. Investors can
switch through a host of funds that are made available.
There is no flexibility in mutual funds. The fund
manager controls the allocation of his portfolio.
6. Tax benefits / Tax efficiency
Under section 80C of the Income Tax Act, premium
on ULIP investments are allowed as deduction from income up to a limit. Mr.
Sharma benefits from ULIP proceeds as they are tax-free in the hands of
investors under Section 10(10D).
Only ELSS funds qualify for tax benefit under
section 80C, so investments up to a maximum of Rs. 1,00,000 in ELSS are allowed
as deduction from income. But ELSS proceeds are not tax-free. They attract
securities transaction tax (STT) on redemption.
Non-ELSS mutual funds have varying tax
implications on redemption depending on the nature of the mutual fund viz.
equity-oriented, debt-oriented, money market or liquid fund.
Conclusion
ULIPs and mutual funds both have their benefits,
and comparing them is like comparing apples and oranges. But it is important as
an investor to consider that ULIPs are long term plans. As a product, ULIP have evolved
with time, they much better than they were in their earlier edition.
If liquidity is the main concern then it is
better to go for mutual funds without lock in period. But ULIPs offer an
additional option to switch funds to enhance or protect the fund value. They
come with lower costs and lesser risks in the long run.
As a hybrid product, ULIP offers dual benefit of
life insurance cover and market-linked investment. As far as income tax
implication is concerned, ULIP plan can be considered to be superior. Also,
insurance coverage inbuilt in the plan is an added bonus.
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