As we enter the “tax planning” season from January to March, people look to invest in what is best for them. However, understanding what is best is not just a matter of perception or an investment communication from the company selling financial products. It requires a proper understanding of the product and an objective comparison of the features of multiple products to gauge which one is suitable for you. Here are some factors that can help you draw comparisons between mutual funds (MFs) and unit linked insurance products (ULIPs).
Reason to scratch the surface
It is well-known that expenses charged by ULIPs are relatively higher than those on MFs. Often, we are advised to invest in a combination of MFs and term insurance, which is cheaper. But you may like to scratch the surface. ULIPs with higher expenses have been mis-sold to people; but if you know what parameter to look at, then you can analyse for yourself. One of the reasons to not summarily reject ULIPs is that there is an inherent tax advantage. Apart from the tax savings under section 80C of the Income Tax Act, on investments of up to Rs 1.5 lakh, future proceeds from ULIPs are tax free under section 10(10D). It goes against the grain, since insurance is not supposed to be an investment vehicle. In this case, the investments are maturing or coming back to you, free of tax. You get this tax benefit on investment because it is packaged with insurance. However, as a consumer of financial products, you have options. For comparison purposes, tax benefit under section 80C is available in ELSS funds, but that is the only category of MFs eligible for 80C benefit. There are retirement solution funds in the context of 80C, but those are only a few. In contrast, all insurance products qualify for section 80C. ULIP proceeds are tax-free under section 10(10D), provided the premium paid in a year is within 10 percent of the sum assured. Keeping this in mind, insurers adjust the sum assured suitably while designing the product, except the single premium ones. Equity funds are subject to long-term capital gains at 10 percent above Rs 1 lakh, for a holding period of more than one year.
Factors for comparison
The most debated issue, in the context of comparison between MFs and ULIPs, is the relatively higher expenses charged by ULIPs. This is broadly correct; but, for an objective comparison, you have to do some data mining. For MFs, the data is easily available; you just have to visit the fund house’s website and the expenses charged to all funds, on a daily basis, is available in excel format. For ULIPs, the expenses are mentioned somewhere in the product brochure, but you have to search for them. And they do not come across as the history of expenses charged, but just as a mention in the literature. In other words, while there are a few ULIP products with relatively lower expenses, you have to hunt for those. Given that ULIPs are investment vehicles with an insurance wrapper, performance is relevant. In MFs, there are multiple equity, debt and hybrid schemes, and the performance data is easily available. In ULIPs, there are equity funds – large, mid, multi-cap, etc. – and debt funds – long maturity, short maturity, etc. The performance data is not as easily available as MFs, but it is possible to dig it out from certain third-party websites.
Again, NAVs of MFs are declared post-expenses, whereas the performance ULIPs (NAV to NAV) is given pre-expenses. In most cases, the expenses of ULIPs are higher than those of MFs. For a ranking of ULIPs on the basis of cost and fund performance, you may refer to the CRISIL ULIP ranking report. It assigns cluster ranks in categories such as equity large-cap or debt long-term. This will give you a perspective on what the relative standing of a product is, across groups of products ranked on a scale of 1 to 5.
Liquidity is one criterion you have to be mindful of. In MFs, liquidity is available any time. There are certain funds with exit loads, but there is no absolute lock in, except in the case of ELSS funds. You can plan your liquidity by investing in exit-load-free MFs. In ULIPs, there is an initial lock-in, subsequent to which there is limited liquidity available.
Provided you have the time, ability and inclination for data mining, you can objectively compare products; it is possible in today’s digital age and data availability. Otherwise, if you are not convinced of the costs or performance or liquidity of ULIPs vis-à-vis MFs, it is better to go with the conventional wisdom and settle for MFs plus term insurance.