Why
Mutual Funds are better than ULIPs
If you are like most Indians, someone somewhere would have
tried to sell you insurance. An avatar of insurance which would have been
offered to you as a “too good to be true” investment option would have been the
ULIP or Unit Linked Insurance Plan. We explain why ULIPs are not the best
option for you and the alternative, of investing in Mutual Funds, is better.
|
What is a mutual fund
|
What is an ULIP
|
|
The money you invest in a mutual fund is invested in
shares of companies or bonds and debentures.
You are allotted units which represent your share in the
total value of the mutual fund.
|
The money you pay as premium is split into two portions:
A large portion is invested in shares of companies or
bonds and debentures. You are allotted units which represent your share in
the total value of the ULIP.
A smaller portion goes towards insuring your life.
|
ULIPs are sold primarily based on this ‘Two-in-One” promise
and at first glance it seems like a good idea. But as an investor you have to
be careful that you don’t get something that does neither of the two things
very well.
So the comparison is not between ULIPs and mutual funds but
between ULIPs and a combo of Mutual funds + Term life insurance.
We believe the second is clearly a better option.
Why it is a bad idea to combine investments and
insurance.
# 1. Comparing for Insurance
a. ULIPs lead to under insurance: The amount of
insurance available as part of ULIP is generally far less as a large portion of
the premium goes towards investment. Let's try to understand this with an
example. Ravi is in his early 30s and a non smoker. As he just got married, he
wants to buy life insurance.
He has two choices. One is to go for a term plan that will
set him back by Rs. 8000 per annum for a term plan that will fetch his
dependents a sum assured of a crore (Ravi actually needs more than a crore -
more like 2 Crores - so his annual premium expense might actually be roughly
Rs. 16,000).
The other option is a ULIP. For a ULIP, the minimum he needs
to pay each year is generally above Rs. 10,000, just for a possible sum assured
of Rs. 1 Crore. The issue here is that he can't be sure his dependents will get
a crore at least. The sum will depend on his ULIPs performance (which is
difficult to predict).
If Ravi goes with a ULIP, there is a substantial risk of
being under-insured.
b. Term insurance is a standardised product. All
insurance companies provide exactly the same terms and you can easily evaluate
the best policy basis the price (Even claims ratio is no longer a big factor).
c. Term Life Insurance is not linked to the
investment. Your premiums are small and there is no risk of losing it because
you failed to make a large premium payment due to financial constraints.
# 2. Comparing for Investments
a. The investment component of ULIP is more expensive
than a mutual fund in terms of charges - maximum reduction in yield for ULIPS
allowed at 4% in the 5th year of the policy vs 2.5% maximum for equity mutual
funds. Read more here.
There is also the case of multiple charges levied on a ULIP.
There are 6 extra charges apart from mortality charges. They are Premium
Allocation Charge,Fund Management Fees, Policy/ Administration
Charges, Surrender Charges, Fund Switching Charge, Service Tax
Deductions. This substantially increases the complexity that is involved in
choosing a ULIP versus a mutual fund or a term insurance plan.
b. The track record of ULIPs is not available for
analysis separately whereas you can compare and evaluate the best mutual funds
easily.
c. If your ULIP investment is not doing well,
switching to a better one is not as easy as in the case of a mutual fund. Not
only do you lose money in charges but you also lose the associated Insurance
and may have to go through the process of medical underwriting again.
# 3. Comparing tax benefits
ULIPS are often pitched as tax saving investments because
the entire premium can be claimed towards Sec 80C (apparently a “Three-in-one”
product).
Even on this front, keeping investment and insurance
separate works better for you.
Buy the Term Insurance you need. The whole premium is admissible
for tax saving.
Then invest the amount you plan to into tax saving funds
(ELSS) with much higher historical returns and lock in of only 3 years. The
saved amount is admissible for tax deductions.
Conclusion
In almost every conceivable way, ULIPs lose out to dedicated
insurance or investment products. So if insurance is your main goal, go for a
term plan. If your goal is pure wealth creation, mutual funds are the best way
to go.
Happy Investing
Source:Scripbox
