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Jul 03, 2012, 04.08 PM IST
Though Mutual funds and ULIPs both expose investors to market risks, these products differ on several critical aspects like returns potential, charges, liquidity, etc. Let’s look at some aspects of investing and understand how these two popular products fair against each other.
Higher fee, in addition to a declining market, was a double whammy for investors. There was much noise from investors' community which forced insurance companies to restructure the product. The new ULIP is a much better product from safety point of view but it also gives you less return than what it provided earlier.
In comparison, mutual funds are a pure investment product. There are different types of mutual funds based on the risk exposure. Equity oriented mutual funds invest major part of the fund in equities. Hybrid funds or balanced funds invest in both equities and debt. Debt funds invest in bonds and fixed income securities. Let’s look at some aspects of investing and understand how these two popular products fair against each other.
Risk exposure - ULIPs are a relatively less risky product because they are insurance products. Even though ULIPs have great variety of products available investing in equities and bonds, they have to be more careful in investment because of the nature of insurance products. Mutual funds are of various types as explained above. Equity oriented mutual funds are more risky than the hybrid ones and hybrid mutual funds are more risky than the debt funds.
Potential of Returns - Since ULIPs invest in relatively low risk products, the potential of returns is also low. The reason is that they have to promise sum assured irrespective of whether the plan makes money. Mutual funds are of different varieties. Equity oriented mutual funds give higher returns than the hybrid ones. Hybrid mutual funds offer better returns than debt funds.
Lock-in period - Since ULIP is an insurance product, insurance companies define a lock-in period for investment. Hence if an investor buys ULIP, he or she cannot sell before the lock-in period of 3 to 5 years depending on individual ULIP products and the structure. Most of the mutual funds typically do not have any lock-in period. You can buy and sell mutual funds anytime. There is a certain type of mutual funds, known as closed fund, which have lock-in period of 3 years.
Liquidity - Liquidity is defined as the ease with which investors can redeem their investment. It is also about time it takes to receive your investment back after redemption. Needless to say, mutual funds are more liquid since it is more widely traded in the market.
Charges - The advantage of mutual fund is its low charges and professional management. The management fee of mutual funds is typically 1% to 2%. ULIP charges are higher.
Important Points to keep in mind
Investors should understand the difference between investment and insurance. Never mix these two important aspects of your financial life. The purpose of insurance is to protect your family in case of any exigencies. The purpose of investment is to build wealth overtime. Mutual funds are great product to earn higher returns and build wealth overtime. Investors should stay with mutual funds for longer time to earn higher returns. At the same time, when investors buy ULIP, it is good to continue with it till the maturity.
One major advantage mutual funds have over ULIP is their history. Mutual funds are in the market for quite a number of years and hence investors can look at the history of returns. The data point available in the market to help investors to select right mutual fund is vast. The same is not available for ULIP.
ULIPs and Mutual funds offer a variety of products based on risk profile. Investors should understand their risk profile and investment period and then decide accordingly. If an investor has low risk profile and an investment horizon of 3 years, investing in ULIPs or mutual funds with major portion in equity is not a good idea. Similarly an investor with longer investment horizon and high risk appetite should go for equity oriented mutual fund or ULIPs with bigger exposure to equities.
Finally, even when investors have bought ULIP as insurance, they must take term insurance to have sufficient protection. The sum assured in term insurance is very high compared to ULIP or any other insurance plan. Term insurance products are pure insurance plan where a large sum is paid to your family members in case of any eventuality. If nothing happens to the insured, there is no disbursement of money.
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