Where to invest- ULIPs versus Mutual Funds?
Ever since the long-term capital gains tax has been introduced on gains from Equity Mutual Funds, there has been a buzz amongst investors about whether investing in ULIPs (Unit Linked Insurance Policies) is better than investing in Mutual Funds.
The reason ULIP policies are popular among investors is because they are marketed and sold as a great investment option, which also provide insurance cover. ULIPs are advertised as ‘the perfect product’, which combines the features of both, an insurance cover and Mutual Funds, under a single plan. Mis-selling of these products is rampant in the industry, as insurance agents receive huge commissions for selling them. Such incentives to agents ensure that there is a constant selling and advertising of ULIPs. The annual ULIP payout that you receive is only a fraction of your annual income. Therefore, it is clear that your ULIP policy will not be able to meet your life insurance needs. Thus, the very point of investing in a ULIP for insurance is proved worthless.
Although ULIPs have emerged as a good alternative to Mutual Funds as a tax-saving instrument, taxability alone cannot be the parameter to decide on a good investment option.
Before we get to a conclusion about which investment is better, it is important to understand both the products.
ULIP is an investment-oriented insurance plan. In ULIPs, a portion of your premium goes towards charges (explained below), a small portion goes towards providing an insurance cover, and the rest gets invested in a fund of your choice. The funds are managed by a fund manager and you are allocated units of the selected fund.
Mutual Funds, on the other hand, are purely an investment vehicle, that pool in the savings of many investors and invest them in diversified instruments. They are managed by fund managers, who invest the money in line with the investment objective of the fund. Mutual Funds too have some costs, but they are lower than those of ULIPs. Since the commission for those selling Mutual Funds is very low, unlike ULIPs, there is lesser mis-selling and more disclosures.
So, which is the better avenue of investment– ULIPs or Mutual Funds?
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Charges
Apart from mortality charges (cost of insurance), ULIPs have many other charges like Premium Allocation Charges, Fund Management Charges, Administration Charges, Surrender or Discontinuance Charges and Switching Charges, etc. These reduce the overall returns from the policy. In comparison, the costs associated with investing in Mutual Funds are much lower. Generally, Mutual Funds have only fund management charges and exit load (if any on early redemption).
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Returns
In ULIPs, due to the charges mentioned above, the amount that gets invested to generate returns, is much lower than the actual premium paid. This significantly impacts the returns that ULIPs can generate. For example, if a person invests Rs 100, 4% which is Rs 4, gets deducted as Premium Allocation Charges, and only Rs 96 is invested. Whereas in Mutual Funds, the entire Rs 100 gets invested in the fund.
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Liquidity
ULIP investments have a lock in period of 5 years, making them an illiquid investment. Hence in case of any emergency, you cannot encash your policy.
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Tax Saving
If the idea of investing in ULIP is to get the benefit of Section 80C deduction, a better option would be to invest in ELSS (Equity Linked Savings Scheme). ELSS is a Mutual Fund that qualifies for the same deduction. Further, it has lock in of only 3 years, as compared to the 5-year lock in period of ULIPs. In addition to better liquidity, ELSS have historically generated much better returns than ULIPs in the long run.
Given below is a table comparing the costs associated with ULIPs and Mutual Funds.
| Particulars | Charges | |
|---|---|---|
| ULIPs | Mutual Funds | |
| Premium Allocation Charges | 4% to 5% (first 5 years) 2-3% (post 5 years) |
NIL |
| Fund Management Charges | 1%-2.50% p.a. | 2-2.75% p.a. |
| Policy Administration Charges | Rs. 1200-2000 p.a approx. | NIL |
From the table above, it is clear that the amount invested decreases when it comes to ULIPs.
Given below is the comparative analysis of 5-year historical returns generated by ULIPs and MFs.
| Type of Fund | ULIPs | Mutual Funds | ||
|---|---|---|---|---|
| 5 Year Historical Returns | ||||
| Pre-expenses | *Returns Net of Expenses | Pre-Tax | **Post Tax | |
| Large Cap | 15% | 12% | 15% | 13.82% |
| Balanced | 12% | 9% | 13% | 11.95% |
| Multi Cap | 15% | 12% | 18% | 16.64% |
| Mid Cap | 22% | 19% | 24% | 22.32% |
*As per IRDA guidelines maximum expenses of 3%
** LTCG Tax impact is after considering holding period of 5 years
It is evident from the data that even if we consider the impact of Long Term Capital Gains tax of 10% on historical returns, Mutual Funds still outperform ULIPs.
Mutual funds on the other hand, are a more liquid form of investment. Open-ended Mutual Funds have no lock in and can be liquidated at any point of time. However, there may be minimal exit load charges applicable, if funds are redeemed before a specified period (usually 1-3 Years). Thus, from a liquidity perspective, Mutual Funds are a much better investment option.
While an investor should keep in mind all these points, the most important thing to remember is that you should ‘Never mix investment with insurance’ . ULIPs do exactly this, and hence, it is much wiser to opt for a term plan. Since the premium you pay for the same amount of cover will be much lower, the balance can directly be invested into Mutual Funds.
The ideal situation would be consulting a trusted financial planner while taking any investment decisions. Their unbiased approach, expertise to compare and analyse various products help them recommend the best investment option for you, based on your financial goals, risk profile and overall financial situation.
Team HF
Happyness Factory is a Goal Based Planning platform. We aim to spread financial literacy and help people make sound financial decisions.
12 Mar, 2018