Mutual Funds vs ULIPs

How MFs are better than ULIPs ?

12/25/2011 Richa Chandra

Unit Links Insurance Plan (ULIP) and Mutual Fund (MF) are the two most preferred options for a part time investor to invest into equity. Unit Linked Insurance Policies (ULIPs) is a good investment avenue which is closest to mutual Funds in terms of their structure and functioning. In mutual Funds, Investors in ULIPs are allotted units by the insurance company and a net asset value is declared for the same on a daily basis. The ULIP have the option of investing across various schemes similar to the ones in mutual funds. We have diversified equity mutual Funds, balanced funds and balanced funds. Generally Speaking ULIPs can be termed as mutual Funds schemes with an insurance component. ULIPs have a market linked investment instrument, as well as a life insurance instrument. Mutual funds, however, are purely an investment instrument. First question that we need to answer while buying ULIP is Do I need to buy insurance? 1) Does the person seeking insurance have any financial liabilities? 2) If something happens to the person, Is there someone who can be in a financial crisis? If the answer to the above two question is yes, I NEED TO BUY INSURANCE. Now let us compare ULIP and MF based on certain well known facts: 1) Insurance ULIPs provide you with insurance cover. MFs dont provide you with insurance cover. But this insurance cover is not for free. Mortality charges (i.e. the price you pay for the insurance cover) get deducted from your investment. 2) Entry Load ULIPs generally come with a huge entry load. For different schemes, this can vary between 5 to 40% of the first years premium. MFs do not have any entry load. Here MFs have a huge advantage. If we consider a conservative market return of about 10-15% you may get a zero percent return in the first year in case of ULIPs.

3) Maturity ULIPs generally come with a maturity of 5 to 20 years. That whatever money you put in, most of it will be locked-in till the maturity. Tax saving MF ( Popularly called as Equity Linked Saving Scheme or ELSS) come with a lock-in period of 3 years. Other MFs dont have a lock-in period. Again MFs have advantage over ULIPs. ULIPs do allow you to take money out prematurely but they also put penalties on you for doing that. 4) Compulsion of Investing ULIPs would generally make you pay at least first three premiums. MFs dont have any compulsion on future investments. If you have invested in a MF this year, and in the next year you dont have enough income or money to do investments you can decide not to make any investmets. Also if you notice that the MF that you invested in is not giving good returns as compared to some other Funds scheme, you can decide to invest in some other MF. 5) Tax Saving Both the ELSS and ULIP come under 80C and can save you tax. Returns in the both form of investments are tax free. 6) Market exposure ULIPs give you both moderate and aggressive exposure to equity market Debt and Liquid MF let invest with low risk, but dont give you tax benefit. ULIPs need not be aggressive in equity exposure. That is ULIPs need not keep more that 60% of their funds in equity market. ULIPS also allow to change your equity market exposure. Thus it can help you time the market and still give you tax savings. If a MF has a less than 60% exposure to equilty market the returns from it are not tax free. Thus you dont get to take a conservative stand on returns. 7) Flexibility of time of redemption ULIP will get redeemed on maturing. Premature redemption is allowed with some penalty.

In MF Premature redemption is not allowed. For a open ended scheme one can redeem the MF anytime after maturity. This is mainly useful if the market is down at the maturity time of the investment. In case of ELSS you can wait till the market comes up again and then redeem them. ULIP scheme wont allow you to wait. Thus, there are some key suggestions: 1) If you wish to take a aggressive exposure to equity market, go ahead any buy MF. ULIP wont be able to give you similar returns. 2) If you think you are not disciplined enough to make regular investments and need a whip to make you invest, invest in ULIP. 3) If you want to take a low exposure to equity market and still get tax free returns, invest in ULIP but make sure that fund you are invested is conservative fund. 4) If you want Insurance cover and also good return on investment. I would suggest that you invest in MFs and take a term plan. The truth is that ULIPs are the extremely complex financial products. And they are very much expensive. Here are some shocking facts about ULIPs. Fact: 1 Do you know that ULIPs just give you the life cover that is only 5 times your annual premium? This means that for every Rs.1 lakh of insurance premium a year, you will get just Rs.5 lakhs of life insurance cover. Now, just as yourself that what if you die today? Will your family survive on just 5 lakh of sum? Probably not. You will need much more life insurance cover than ULIPs actually offer. You will probably need Rs.50 lakhs or even more life insurance cover so that in your absence your nominees can survive on that sum.

Lesson: Always go for Term Insurance to cover your life. Insurance is not about return on your money but its about covering your life in case of your sudden death. Fact: 2 Do you know that ULIPs charge 20-80% premium allocation charge on your first 3 premiums? Well, yes. this is very true. Just download any ulip brochure from the internet and see how much premium allocation charges they charge you. So in very clear way, if you invest Rs.1 lakh in ulips than Rs.20-80k will go towards premium allocation charges and the rest will go towards long term investing. Lesson: This is not the scenario with mutual funds. Mutual funds have 0% entry load. This means that everything that you invest in mutual funds will go towards long term investing and not for paying various kind of charges. Fact: 3 ULIPs will charge you half a dozen types of charges In other words, ulips are not better than the mutual funds in any way. The best combination is Term Insurance + Equity Mutual funds in India. This is because ulips are nothing but the opaque mutual funds which will charge you lots of entry loads. So stay away from ulip and invest in term insurance and equity mutual funds. 1. What is the mode of investment in Mutual funds and ULIP? The investors in mutual Fundshave the option of either making lump sum investments or investing using SIP (Systematic Investment Plan) route which entails commitments over long time horizons. The minimum investment amounts are laid by the fund house. ULIP investors also have the choice of investing in a lump sum (single premium) or using the conventional route, i.e. making premium payments on an annual, half-yearly, quarterly or monthly basis. In ULIPs, determining the premium paid is often the starting point for the investment activity. ULIP investors also have the flexibility to alter the premium amounts during the policy's tenure. For example an individual with access to surplus funds can enhance the contribution thereby ensuring that his surplus funds are gainfully invested; conversely an individual faced with a liquidity crunch has the option of paying a lower amount (the difference being adjusted in the accumulated value of his ULIP). The freedom to modify premium payments

at one's convenience clearly gives ULIP investors an edge over theirmutual Funds counterparts. 2. How is an expense determined in ULIPs and mutual Funds? In mutual Funds investments, expenses charged for various activities like fund management, sales and marketing, administration among others are subject to pre-determined upper limits as prescribed by the Securities and Exchange Board of India. Similarly funds also charge their investors entry and exit loads (in most cases, either is applicable). Entry loads are charged at the timing of making an investment while the exit load is charged at the time of sale. Insurance companies have a free hand in levying expenses on their ULIP products with no upper limits being prescribed by the regulator, i.e. the Insurance Regulatory and Development Authority. This explains the complex and at times 'unwieldy' expense structures on ULIP offerings. The only restraint placed is that insurers are required to notify the regulator of all the expenses that will be charged on their ULIP offerings. Expenses can have far-reaching consequences on investors since higher expenses translate into lower amounts being invested and a smaller corpus being accumulated. ULIP-related expenses have been dealt with in detail in the article "Understanding ULIP expenses" 3. How does portfolio disclosure done in Ulips and Mutual Fund? Mutual Funds houses are required to declare their portfolios on a quarterly basis, almost fund houses do so on a monthly basis. Investors get the opportunity to see where their moneys are being invested and how they have been managed by studying the portfolio. While one school of thought believes that disclosing portfolios on a quarterly basis is mandatory, the other believes that there is no legal obligation to do so and that insurers are required to disclose their portfolios only on demand. Some insurance companies do declare their portfolios on a monthly/quarterly basis. However the lack of transparency in ULIP investments could be a cause for concern considering that the amount invested in insurance policies is essentially meant to provide for contingencies and for long-term needs like retirement; regular portfolio disclosures on the other hand can enable investors to make timely investment decisions.

4. What is the Tax benefit through ULIP and Mutual Funds? ULIP investments qualify for deductions under Section 80C of the Income Tax Act. This holds well, irrespective of the nature of the plan chosen by the investor. On the other hand in the mutual Funds domain, only investments in tax-saving funds (also referred to as equitylinked savings schemes) are eligible for Section 80C benefits. Maturity proceeds from ULIPs are tax free. In case of equity-oriented funds (for example diversified equity funds, balanced funds), if the investments are held for a period over 12 months, the gains are tax free; conversely investments sold within a 12-month period attract short-term capital gains tax @ 10%. Similarly, debt-oriented funds attract a long-term capital gains tax @ 10%, while a shortterm capital gain is taxed at the investor's marginal tax rate. Despite the seemingly similar structures evidently both mutual Funds and ULIPs have their unique set of advantages to offer. As always, it is vital for investors to be aware of the nuances in both offerings and make informed decisions. Investing in selected mutual funds will help you to gain more than Ulip. Remember mutual funds are subject to market risks. Hence the growth depend on the Market conditions. Investing in a mutual fund portfolio will offer the benefit of diversification to the client. The investor will reap the reward of diversifying across several fund management styles. On the other hand, by investing all his money in just one ulip, the client would be committing his entire corpus to just one style of investment. this can prove to be quite risky over the long term. However, a ulip investor can change the allocation of equity vs. debt in his ulip holding depending upon prevailing conditions and risk profile. Adjustments can be made to your mutual fund portfolio. If you believe you have made a wrong investment decision, you can redeem your investment in a particular mutual fund and invest in another one. Such adjustments are not entirely feasible in a ULIP. On the other hand, ULIP is a very transparent and flexible insurance policy. Premiums paid can be single, regular or variable. The payment period too can be regular or variable. The risk cover (insurance cover) can be increased or decreased.