Risk involved in Unit Linked Insurance Plans
Unit Linked Insurance Plans (or ULIPs) have become quite a popular option among many investors. It is a product that offers a life cover along with an investment option. Part of the premium you would pay in a ULIP goes towards insurance and the balance is invested in a fund of your choice. With every insurance company offering different plans and a variety of funds, a ULIP investment is borne with a certain element of risk. What are these risks?
Let us begin by understanding what is meant by risk.
The term risk means the variability in the rate of return of an investment. It is the amount by which the returns of an investment may increase or decrease from your expected value. The wider this gap, the greater is the risk you experience. Your investment time horizon, age, surplus cash position and investment goal all determine your risk taking ability. Also the higher the expected return from an investment, greater is the risk borne by it.
The Risks in ULIP
Even though ULIPs are predominantly an insurance tool, it is fraught with risks owing to the element of capital market investment it bears. As an investor in ULIP here is what you may experience.
- Market Risk: ULIP are directly affected by the ups and downs in the capital market. Whether it is volatility in the equity market or an increase or decline in interest rates, the Net Asset Value of the fund is impacted and may show a rise or fall.
- Lack of Guaranteed Returns- ULIP returns is not guaranteed. The investment risk of a portfolio is borne by the policy holder. The performance of the underlying fund and expertise of the fund manager put together determine the gains or losses the investment would make.
- Liquidity Risk- ULIP being an insurance product comes with a lock-in period of 3 to 4 years. They are thus low in liquidity and you may loss out a certain percentage of your investment if you wish to redeem during this lock-in period.
- Past performance indicator: Though the past performance of the ULIP may seem to be attractive, what one should keep in mind is that this may not follow in future. Past performance of a fund is not an indication of its future performance, as predicting market behavior and volatility is a near to impossible task.
- High cost structure- The charges in a ULIP are quite high. A high fee structure especially during a decline in the market, affects the returns on a ULIP.
Type of Funds in ULIPs
Insurance companies offer a range of fund options in a ULIP plan to suit the different objectives and risk profiles of investors. Here are the different funds that are commonly offered. The risk and the returns vary from fund to fund.
|EQUITY FUNDS||DEBT/FIXED INCOME FUNDS||MONEY MARKET FUNDS||BALANCED FUNDS|
|Primarily invests in equity market||Primarily invests in bonds, government and fixed income securities.||Invests in bank deposits, cash and money market instruments||Combines equity and debt investments|
|Medium to high risk||Low to medium risk||Low risk||Medium risk|
|Aims towards capital appreciation||Aims at capital preservation||Primarily for short term investors||Capital preservation with moderate levels of capital appreciation|
Getting the best out of your ULIP
Unit Linked Plans offer investors the combination of security as well as growth. To get the most out of your ULIP, here is what you need to do.
- Stay invested for the long term: ULIPs are for long term investors with a horizon of 10 to 15 years. In the long term, risks associated with market fluctuations are greatly reduced, and the investment could fetch higher yields. Also, the initial policy years of a ULIP have a high cost structure. Over a period of time, this cost comes down substantially, and therefore a larger part of the premium is invested in the chosen fund, fetching you more from your investment.
- Understand your risk appetite: Your risk appetite is based on your needs, cash position and investment horizon. Before investing in a ULIP, have a clear understanding of your risk taking ability. Know what you are paying for and what the possible outcomes could be, before investing in the plan.
The author is CEO of MyInsuranceClub.com