ULIP vs Mutual Funds: Which is a better investment?

A common question on every investors mind is – ULIP vs Mutual Funds – Which is the right choice for me? Let us

The Unit Linked Insurance Plan i.e. ULIP was introduced by the insurance industry in India many years back when the equity market was poised for a take-off and people wanted to take the advantage of capital appreciation. Primarily an insurance product, ULIP enabled investors to ride the market, largely because of its market-linked portfolio. It was a major hit among investors as the bull market generated good returns.

ULIP, over time, began to be used as a speculative product for people wanting to make quick money. But that was far from the truth. Trouble began when the market started it’s southwards journey. Higher fees, coupled with falling share prices, were a double whammy for many investors. There was much noise from the investor community that forced insurance companies into restructuring their products. Finally in 2005, ULIPs came under the purview of Insurance Regulatory and Development Authority (IRDA) and emerged as much improved products from investor’s perspective.

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Unit Linked Insurance Plan i.e. ULIP is sold to the customers as a product that provides the dual benefit of investment as well as insurance. However, it is prudent not to mix investments with insurance.

In comparison to ULIP, Mutual funds (MFs) are pure investment products. There are various types of MFs: While Equity-oriented MFs invest majorly in equities, Debt funds, on the other hand, invest in fixed income instruments and bonds. Balanced or Hybrid funds invest in both debt and equities.

Let’s see who wins when it is ULIPs vs Mutual Funds stacked up against each other:

Ease of investment

MFs offer greater flexibility in investing. In most cases you can start with as little as Rs. 500 per month for a minimum period of one year. Systematic Investment Plans (SIPs), much like monthly installments, is affordable to just about anyone, even college students. It’s a great way to save for a bigger goal in life. You can discontinue an SIP midway with no penalty or financial implications. Your investment corpus remains intact. No wonder SIPs have made MFs hugely popular among all investor classes.

ULIPs, on their part, are more rigid and involve paying a stipulated premium for a minimum five years. If you want to exit the ULIP in the interim, there would be a financial implication, and you may lose part of the premium paid.

Investing in MFs is easier and more acceptable to a larger section of investors.

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Expenses

As determined by Securities and Exchange Board of India (SEBI), the expenses charged by MFs to investors that cover activities like sales and marketing, fund management, administration and others, are subject to limits. MFs, for instance, can charge investors maximum of 2.25% in case of debt funds and 2.5% in case of equity funds on an annual basis for all expenses incurred. All expenses over and above the specified limits have to be borne solely by the fund house.

IRDA too prescribes certain limits. The premium allocation charge is the most expensive part of ULIPs which can’t exceed 10% of the premium. It was much higher before IRDA cracked down in this regard. There are also charges like fund management, policy administration, mortality and surrender charges. IRDA has put a cap on the total charges in ULIPs to 3% for the policies that have a tenure of less than or equal to 10 years and 2.25% on policies whose tenure exceeds 10 years.

Higher expenses lead to lower returns. Expenses, hence, have far-reaching consequences and shouldn’t be taken lightly. MF investors know upfront what to expect from the expenses perspective because of the simplicity of a fund structure. But ULIPs have complex expense structures that may not be easily understandable to all. MFs are more cost effective from the expense perspective and that reflects in their performance, vis-à-vis ULIPs, other factors being the same.

Flexibility for asset allocation

MFs give you the flexibility of choosing a particular sector as well as alternate assets like gold & real estate. Not only that, you also have the option to choose funds across various asset management companies to build your portfolio. Whereas, with a ULIP it is not so, also your choice of funds is limited to the insurance company you choose.

Tax benefits

Premium paid on ULIP investments, up to Rs.1.5 lakhs, is allowed as a deduction under section 80C of the Income Tax Act. ULIP proceeds are also exempt from taxation under section 10 (10D). ULIP premiums have detailed guidelines on the percentage of premium allowable for tax benefits.

On the other hand, only Equity Linked Savings Schemes (ELSS) are eligible for tax benefits under section 80C. Equity Linked Savings Schemes are tax saving mutual funds having a lock-in of 3 years. It comes under EEE (Exempt- Exempt- Exempt) tax structure.

Non-ELSS MFs have diverse tax implications on redemption. It usually depends on the nature of the funds like debt, equity, liquid/money market, etc. However, tax planning should not be the only purpose behind choosing any financial instrument.

Now that, we have already discussed ULIPs and Mutual funds based on few investing parameters. Let’s just also have a look at the comparison between ELSS and ULIPs considering the tax benefit they offer:

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Returns

Return on your investment is, of course, a driving factor in choosing a financial instrument. Let’s take a look at the 10-year returns of the top performing ULIPs and MFs:

Also read: Comparative Analysis of Top 5 ELSS Schemes 2016

So which one finally wins – ULIP vs Mutual Funds?

From the above, it’s clear that MFs have outperformed ULIPs on most counts and are hence better investment instruments. A part of the reason is that MFs have greater liquidity than ULIPs and are more widely traded in the market. If long-term wealth creation is your objective, start early, and go for an SIP in MFs.

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