Mutual Fund vs ULIP: which is better for your portfolio?
Indians are known to be more risk averse than their overseas counterparts. You may not see many Indians doing extreme sports or trying their luck in the stock market. However, the fact remains that people around the world are increasingly turning to 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 ULIP. Many people buy ULIPs (Unit Linked Insurance Plans) thinking they will get the double benefit of insurance and decent returns. However, when it comes to returns, mutual funds fare much better over the long term and have demonstrated the ability to generate substantial returns. ULIPs are insurance policies with the dual purpose of providing insurance coverage and earning you a return by investing. Some ULIP products on the market offer an added element of protection through endorsements or built-in benefits.
However, as ULIPs are underwritten by insurers, the risk profile is different from that of a mutual fund. An insurer, unlike a fund house, is not intended to manage money. Its purpose is to ensure payment of the sum insured in the event of death, disability or accident of the insured. As a result, the insurer takes a long-term view of investments and tends to favor bonds and term deposits over equities. So a ULIP may not be the best product for an aggressive investor. In addition to this, ULIPs generally require a larger initial investment and premium amounts are periodically revised.
In terms of yield, ULIPs and large-cap mutual funds showed similar performance. Over a ten-year period, the average returns for the large-cap mutual fund category are 12.23% annualized, while ULIPs have returned 11.52%. Therefore, there is not much difference in performance, but in terms of cost, mutual funds are much better. The returns or IRR of ULIPs are misleading because the returns or net asset value of ULIPs do not take into account plan expenses. In the case of mutual funds, plan expenses or fund management fees are rolled into the net asset value. In insurance products, it is not inclusive. Instead, it is debited directly from the corpus.
ULIPs charge a multitude of fees. They include premium allocation charges (up to 12.5% of the annual premium), mortality charges (depending on your age and sum insured), fund management charges (up to 1.35%), policy administration fee (up to 5% per annum or Rs 500 per month), fund change fee (Rs 500 per change), endorsement fee, amendment fee ( to change the duration of the policy, sum insured, premium redirection to Rs 500 per transaction), partial withdrawal fee (Rs 500 per transaction) and service tax. By comparison, mutual funds charge a graduated total expense ratio (TER) that differs by plan category, but typically ranges between 1% and 2.25% per year. Expenses decrease as plan assets under management (AUM) increase.
When you buy ULIPs, you have to pay the premiums every year and they can increase every year due to inflation or changes in your age. This makes it difficult for some people, especially those with irregular incomes.
On the other hand, mutual fund schemes are run by professional managers who study market trends and invest the corpus accordingly. The manager does all the work, from picking the right stocks to determining how much of the portfolio should be invested in various sectors. As a result, investors don’t need to spend time watching the markets; instead, they can sit back and relax while their corpus grows steadily.
Mutual funds provide regular income in the form of dividends and capital gains from securities held by the fund house. By contrast, an insurance company’s returns are generally tied to the performance of the underlying assets. This means that returns could vary significantly from those of a well-managed mutual fund.
Mutual funds and ULIPs are regulated by SEBI. This ensures that the investor’s money is safe and earns interest, while helping the program grow. ULIPs as well as mutual fund schemes such as ELSS (Equity Linked Savings Scheme) offer tax benefits under Section 80C.
ULIP is essentially an insurance product. ULIPs have a blocking period ranging from three to five years, depending on the nature and structure of the investment program. Mutual funds generally have a lock-up period of one year, but in some cases, such as ELSS, the lock-up period is three years.
Ideally, one should buy term insurance to cover their insurance needs and invest in mutual funds to build up a decent corpus. A term plan is much cheaper; it may cost only 0.25% compared to ULIPs which may cost around 4% to 6% due to high administrative costs.
Although these points may seem important, you should always remember that the decision to invest in a mutual fund or an 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 advice from a qualified financial professional to make the right investment decision.
(By Abhinav Angirish, Founder, Investonline.in)