A sound investment strategy can aid you to increase your wealth and could secure your family’s financial future. ULIPs (unit-linked insurance plans) and mutual funds are both attractive investment vehicles for investors looking to create wealth in the long-term.
What is a mutual fund?
A mutual fund is a financial vehicle wherein an AMC (asset management company) manages the money of several investors. The collected funds are further invested in different securities such as bonds, stocks, and money market instruments, etc. The performance of your mutual fund scheme is directly proportional to the performance of these underlying securities.
Mutual funds are pooled investments that are managed by professionals known as fund managers. Fund managers are mutual fund experts who have in-depth knowledge about the complexities and volatilities of the financial markets and make appropriate asset allocation decisions.
What is a Unit-linked insurance plan?
A unit-linked insurance plan, or ULIP, is a combination of investment and insurance. ULIPs are insurance policies that offer an investor the potential to create wealth while simultaneously providing them with the security of a life cover.
Under ULIPs, a part of the premium goes towards providing the investor with a life insurance cover. The rest is pooled and invested in debt or equity instruments or a combination of both to help create wealth in the long-term.
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Difference between ULIPs and mutual funds
To gain some perspective on ULIPs and mutual funds, you must first understand the difference between the two investment products. Following are some of the significant differences between mutual funds and ULIPs.
- Investment objective
A mutual fund is a pure investment product that offers the sole benefit of creating wealth and has potential to generate reasonable returns in the long-term. On the other hand, ULIPs are primarily an insurance product with the added advantage of being a market-linked investment.
2) Return on investment
The returns on ULIPs can be dynamic as they invest in equity, debt, or a combination thereof. The returns on mutual funds vary too depending on the type of scheme opted for and can range from low to high.There is no guarantee of minimum returns in mutual funds
3) Lock-in period
As ULIPs are insurance products, insurers define lock-in period of generally five years for these investments. Investors cannot redeem their investments before this lock-in period is over. On the other hand, most mutual funds, especially open-ended mutual funds, do not have a lock-in period, except for ELSS funds, which have a lock-in period of 3 years.
4) Transparency
Recent regulatory amendments by the IRDAI have made ULIPs quite transparent; they now provide upfront information on fund allocation. In the case of mutual funds, fund houses are mandated to provide a detailed report of the mutual fund investments. Financial markets’ regulator SEBI has advised fund houses to provide detailed information on asset allocation, portfolio holding, active fund manager(s), fees charged, etc., w.r.t different schemes.
5) Taxation
Tax on mutual funds: LTCG (long-term capital gains) and STCG (short-term capital gains) tax of 10% and 15% (plus applicable surcharge and cess) , respectively, is levied on equity funds depending on the holding period. For debt mutual funds, LTCG tax is levied at 20% (plus applicable surcharge and cess) after indexation, while STCG tax is levied according to the investor’s income tax slab. Equity-Linked Savings Scheme (ELSS) funds qualify for a tax deduction of up to Rs 1.5 lac under Section 80C of the IT Act, 1961
Tax on ULIPs: Returns on ULIPs are tax-free under Section 10(10D) of the Income Tax Act, 1961.
6) Expense
Investing in mutual funds incurs professional management fee as well as operational fee, collectively referred to as an expense ratio. Some mutual funds also charge an exit load, i.e. a charge for leaving the scheme. When it comes to ULIPs, the charge levied includes premium allocation charge, fund management charge, administration charge, mortality charge, etc.
7) Risk cover
Under ULIPs, nominees are compensated for the sum insured in case of the policyholder’s untimely demise. However, in the case of mutual funds, the investments are transferred to the nominee.
8) Ideal time to invest
Mutual funds are the ideal investment choice under the following circumstances:
- If someone wants to invest for a short- or long-term goal
- If someone wants to build your wealth
- If someone is looking for reasonable returns on investments
ULIPs are the ideal investment choice under the following circumstances:
- If someone is looking for a tax-saving investment
- If someone is seeking a life insurance policy
- If someone wants to invest for a long-term horizon.
ULIP vs. mutual fund
There are following differences between ULIP Plan and Mutual funds”:-
- ULIP Plans are regulated by IRDAI and on the other hand mutual funds are regulated by SEBI.
- There is dual purpose of ULIP plans first is insurance and then the return on investments and mutual funds are to generated more money from investments.
- ULIP plans are always long term and on the other hand mutual funds are came up with short term, medium term and long term financial goals.
- ULIP plans provide tax exemptions up to 1.5 lacs under section 80C, on the other hand there are ELSS plans in mutual funds which provide tax exemptions up to 1.5 lacs under section 80C
- Investments in mutual funds relatively carry higher risks. There is no assurance or guarantee of minimum returns in mutual funds
Which is better? Mutual fund or ULIP?
The decision to invest in mutual funds or ULIPs solely lies with the investor. Before investing in any instrument, an investor should analyse their financial needs. The right investment option is one that aligns with the investor’s financial goals, risk profile, and investment duration. For instance, if investments needs to be liquid, one can consider investing in mutual funds as ULIPs have a minimum lock-in period of 5 years. Of course, not all mutual funds are liquid, and tax saving mutual funds (ELSS funds) have a lock-in period of 3 years. On the other hand, if someone is looking for insurance as well as wealth creation, one can consider investing in ULIPs.
It is always recommended to prioritize your both investments and insurance and don’t mix and match. So try to get endowment plan for insurance and for healthy return buy mutual funds. This will serve your purpose for investment and insurance and you will get maximum benefit from both.