There was a time when stocks were exchanged manually under a banyan tree in Mumbai. We have come a long, long way since. Today, there are hundreds and thousands of financial products available that help you invest your hard-earned money. Depending on your needs, limitations and financial goals, you can opt for any of these to either safeguard your wealth or create more.
Mutual funds are one of the most common investment options today. Simply put, it is an investment vehicle that first accumulates money from investors, and then invests it on their behalf in different assets to earn a return. It is much like the bus you take—the driver takes the passengers to a single destination. In this case, the driver is the fund manager, the bus the mutual fund scheme, and the passengers the investors.
MFs and ULIPs
Often, though, mutual funds are confused with another financial product—Unit-Linked Insurance Plans, better known as ULIPs. These are insurance policies with the dual purpose of providing an insurance cover as well as earn you a return by investing. The insurance company also floats a fund, just like the mutual fund house, to gather money from investors. It then invests this money across assets like stocks and bonds. Sounds a lot like mutual funds, right? But they are not the same.
The differences
The biggest difference lies in the fact that mutual funds do not offer a life cover; only ULIPs do. This is the money the insurance company promises your family in case of an untimely death.
Let’s understand this using an example.
Mr A invests 50,000 in a ULIP, while Mr B buys mutual fund units with the same amount. All of this money is invested for both Mr A and Mr B. However, every month, a part of Mr A’s investment is taken as insurance cover, which acts as the ‘protection element’ or ‘insurance premium’. This buys him an insurance cover of 5 lacs. In Mr B’s case, he would need to buy an insurance policy separately to get a life cover. In case Mr A meets with an accident and passes away, the insurance company would compensate his family with 5 lacs or the fund value, whichever is higher. This is not so for Mr B.
Additional Protection in ULIPs
There are certain ULIP products in the market that offer an additional protection element through riders or inbuilt benefits. These types of ULIP products would best suit customers who are saving for a specific need and are worried that these needs might not be met in case they are not around in the future. An example would be saving for the child’s education. Some ULIP products offer a lump sum assured amounton the death of the parent to meet these needs.Additionally, the company continues to pay the fund’s premiums on the parent’s behalf.It also provides a regular income to the family for the rest of the policy tenure.
Tax-savings
ULIPs allow you tax deductions, as per Section 80C of the Income Tax Act. Whatever money you invest in a ULIP is deducted from your total taxable income. This then reduces the money you owe to the government as income tax. Mutual funds, on the other hand, do not always help you reduce taxes. Only ELSS or Equity-Linked Saving Schemes give you such tax deductions.
Charges
ULIPs and mutual funds may seem similar upfront—they both invest across different assets. However, both are structured in a different way, which is why the charges differ too. A mutual fund only charges for managing your money and as exit fee, which is the penalty for selling units soon after you invest in the scheme. ULIPs, on the other hand, levy charges under more heads. These include a premium allocation charge, administration charge and lastly, charges for managing the fund. The amount you invest in a ULIP also includes the insurance premium. This is often called a mortality charge.
The Fund Management Charges for the ULIPs, however, are lower than Mutual Funds, being 1.35% and 2.5% respectively. Moreover, the insurance regulator IRDAI mandates that the total effective charges on ULIPs should not exceed 2.25%. This means, the total charges on a ULIP can never exceed what a mutual fund charges.
High charges tend to eat into your returns. So, in the long run, your ULIP returns are likely to be equal or higher than in the case of mutual funds.
When to ULIP, when to MF
So, when should you opt for a ULIP and when should you invest in a mutual fund?This answer is not straightforward. It depends on your own needs.
First of all, if you need your investment to be liquid—be easily convertible into cash on short notice, then you better opt for a mutual fund. ULIPs have a lock-in period of minimum five years. During this time, you cannot redeem your money. Of course, not all mutual funds are liquid. ELSS funds also have a three-year lock-in period.
Greater options
There are thousands of mutual fund schemes to choose from, depending on the risk and return objectives. There are even funds which mimic an equity index like Sensex or Nifty. You may not get this kind of variety among ULIPs. However, you may find different options amongst ULIPs depending on who you want to protect—yourself during retirement, your kids and so on.
So which one should you invest in?
Before making a decision to invest in either of the financial products, be clear about what you want to achieve from your money
(a) What is your risk appetite?
(b) What is your financial goal? Do you want to save money for retirement or to meet other foreseen expenses?
(c) Do you need cover?
(d) What is your investment horizon?
ULIPs are best suited for individuals with a long term financial plan of wealth creation and insurance. Whether it is for retirement, children’s education or for other financial goals, a ULIP continued till maturity works as an advantage. It gives you the dual benefit of savings and protection, all in a single plan. In addition, ULIP’s are for individuals who are not savvy with the equity market or different fund options available with MF but would like to benefit from long term capital appreciation with investment in equities.
