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The mutual fund industry’s AUM has grown from Rs 4.17 trillion as on 31st March 2009 to Rs 23.80 trillion as on 31st March 2019, more than five and a half fold increase in 10 years.* Similarly, there has been a rise in the sale of ULIP plans of life insurance companies.

This growth story points to the fact that Indians have matured with regards to their investment choices and have started trying their hand and money at alternative investment avenues rather than sticking to the traditional investment options of fixed deposits, gold, real estate, etc. This gets us to the question of which is better, investing in mutual funds or ULIPs. Many of us may be interested in participating in the capital markets but are not sure whether to do so through the mutual fund route or via ULIPs. This is what we shall explore in this write-up.

What is a Mutual Fund?

In simple layman terms, we can call a mutual fund as a pool created by like-minded individuals/entities who wish to invest in the markets and share and benefit by its performance. There are various investment funds to choose from. Each person contributes to a pool or investment fund which is in sync with his risk appetite and objectives. Each investment fund is managed by a fund manager.

A fund manager is a person who has expertise in the buying and selling of shares and has expert knowledge on the functioning of the market, market behavior, trends, volatility, etc. After the necessary market research and analysis, the fund manager invests the pool of money and then monitors and handles it considering prevailing and anticipated market conditions to generate maximum benefit for the investors.

What is ULIP?

A ULIP is a life insurance plan which combines life insurance and investments into a single product. Thus, the policyholder can achieve the twin objectives of life insurance and investments under the aegis of a single product.

The premium paid is split by the insurance company into two parts, one for the life insurance coverage and associated charges and the other is invested in an investment fund chosen by the policyholder as per his risk profile and this portion is managed akin to a mutual fund. To accommodate various risk appetites, most life insurers offer 7-9 investment funds to choose from ranging from debt, equity to balanced funds (debt and equity funds in varying proportions).

This is the broad explanation of these two investment-related products. The common thread in these two options is that they are market-linked and provide returns in sync with market performance. The investment risk is borne by the investor/policyholder. The distinctive features and differences between mutual funds and ULIPs are explained below:

More About Mutual Funds

Mutual funds have been in existence in India since 1963. However, it is only in recent years that it has gained mass appeal and become an investment option of choice for many.

Key Points to Note:

Huge Choice of Investment Funds: Innovation and competition have resulted in mutual funds offering a plethora of investment funds to choose from. There is an investment fund to cater to each of your goals. Equity funds (large-cap, mid-cap, small-cap, multi-cap), debt funds, arbitrage funds, liquid funds, index funds, sector funds, hybrid funds, tax-saving funds, etc.

In short, aggressive and conservative investors, investors with short-term or long-term goals or those with different wallet sizes and age-groups, all can find an investment fund to invest in.

Suitable for Various Goals: With a mutual fund, you can plan to execute a wide range of goals. Products like PPF, NSC, NPS, etc have a handicap i.e they are best to achieve long term goals, however, with a mutual fund you are in a position to plan for any goal be it short term, medium-term or long term.

For eg: For a short term goal such as planning for a vacation a year down the line or for a down payment of a new car you want to buy in a year can opt for ultra short term debt funds or liquid funds.

A couple with a new-born can plan for a medium-term goal such as nursery/school admissions which maybe 3-4 years away through a hybrid fund (mix of debt and equity).

For long term goals that are more than 5 years away from such as retirement, children’s higher education, children’s marriage, etc equity-based funds can be put to work.

Past Performance Data: As mutual funds have been around for many years, there is a lot of data easily available online regarding the fund’s performance from inception, year on year, 3-year performance, 5- year performance, benchmarking with peers, rankings given by various websites/institutions, details of companies where investments are made, fund objectives, etc. All of this can help you make an informed choice.

Easy Liquidity: Mutual funds can be redeemed easily. Most funds levy an exit load for redemptions in the first year and usually after the first year there is no exit load. However, for ELSS funds (these are funds that offer taxation benefits) there is a lock-in period of three years. Close-ended funds also have a lock-in period.

Charges: Expenses vary from fund to fund and typically range from 0.5-3%. Fund management charges are levied and deducted from the NAV daily.

Taxation: Investments made in ELSS funds are tax-free up to Rs 1.5 lakh under section 80C of the income tax act.

More About ULIP

The first ULIP in India was launched by Unit Trust of India (UTI). However, ULIPs gained traction when the insurance sector was opened to foreign investors in 2001. This saw the emergence of many private life insurance companies who actively forayed into the ULIP business. The entry of ULIPs changed the life insurance landscape in India which was dominated by guaranteed products offering low returns. With the ULIP plan, one could invest in the markets and have the potential to earn higher returns.

However, the ULIP charges were high and there was rampant misselling compelling IRDAI to bring about new norms to control this. In 2010, the new age ULIPs were launched with a better charge structure and this has played an important role in ULIPs becoming a much sought out and competitive product.

Key Points to Note:

Dual Benefits: ULIP offers twin benefits of life insurance and investment. The minimum sum assured is equal to 10 times the annual premium for investors below the age of 45.

Lock-in Period: ULIP being an insurance plan has a lock-in period of five years. Surrender of policy or partial withdrawal from the policy fund is possible only after completion of five years. Even if you surrender the policy before five years, the surrender value is payable only on completion of five years. So ULIP is best for those seeking long-term investment opportunities and not for short term benefits.

Charges: On receipt of premium a policy allocation charge (not applicable for online policies) is deducted and the balance is used to buy units of the chosen investment fund. Mortality charges (charges for insurance cover) and policy administration charges (some online policies do not charge this) are deducted from the policy fund every month by the cancellation of units at prevailing NAV. The fund management charge is built into the NAV and is deducted before the computation of the daily NAV. It is capped at 1.35% of the policy fund value in a year.

Switch of Funds: A ULIP policyholder can switch between the various investment fund options available in the policy to make the best of market fluctuations and volatility. This access to various investment funds ranging from pure debt to pure equity to balanced funds makes ULIP a holistic product.

Auto-Switching of Funds: If you are not a market-savvy person or do not have the time or inclination to follow the market news and trends, you can still opt for a ULIP by choosing auto-switching features such as asset allocation fund, wheel of life strategy, systematic transfer of funds, trigger-based portfolio strategy, etc.

Top-up: In case you are having excess funds by way of salary increments, incentives, dividends, etc then you can park these excess funds in your ULIP policy as a top-up. The regular premiums due should be paid before you can make a top-up. As long as the top-up premiums do not exceed 25% of the total regular premiums paid till then, you are not required to buy an insurance cover with the top-up premium. 

Differences Between Mutual Fund and ULIPulip vs mutual funds

Point of comparison

Mutual Fund

ULIP

Nature of product

Only investment

Life insurance + Investment

Tax benefits

Only ELSS funds are eligible for tax benefits up to Rs 1.5 lakh under section 80C

  • Premiums paid up to Rs 1.5 lakh eligible for tax benefits under section 80C.
  • Death and Maturity benefits are tax-free.

Liquidity/Exit

  • Very liquid, no lock-in period.
  • ELSS funds have a lock-in period of 3 years.

It cannot be easily liquidated. Lock-in period of 5 years applicable.

Payment period

  • No compulsory payment period.
  • The investor can pay for a long term or short term.
  • SIPs can be stopped whenever required with no penalties.
  • Single pay
  • Short pay (eg: premium payment for 10 years with policy term 20 years)
  • Regular pay (eg: premium payment term and policy term same)

Payment mode

  • Flexibility to pay in a lump sum or through SIPs or both.
  • SIPs can be weekly, monthly or quarterly.


Annual, Semi-Annual, Quarterly, Monthly

Product tenure

  • Can choose any tenure from short term, medium-term or long term.
  • Min/Max age limits not applicable.
  • Long term product
  • The minimum tenure is 5 years
  • Tenure of product is also subject to min/max age limits of the life insured.

Consequences of non-payment of SIP/Premium

No consequences, you can start, skip and stop SIPs anytime

Premium needs to be paid on the due date or within the grace period failing which policy lapses.

Switching funds

  • Facility not available
  • If the fund is not performing well only option is to discontinue and choose another fund.
  • Switching between various investment funds available.
  • Switches can be used to exploit various market conditions to derive optimum benefits for the policy.

Suitable for

It can be used effectively to plan for all time range goals from short-term, medium-term to long-term.

Best for long term goals i.e goals which are at least five years away.

Riders

Not applicable

Choice of riders for optimum insurance coverage

Now that we have seen what these two investment avenues are how they differ in their features, we reach to the important and obvious question of when to go for a mutual fund and when to opt for ULIPs.

Answers to the points mentioned below can lead you to the option which suits you best.

Understanding That Markets Will be Volatile: Risk-taking ability is essential for investing in Mutual Funds and ULIPs. However, only the risk-taking ability is not enough. The ability to understand what it is like markets to go up and down is also very essential. In case you get spooked every time the market falls and panic and worry about your investments then you are probably better off with a ULIP because of the reasons given below: 

  • Switching of Funds: In case markets become very volatile, you have the option to safeguard your returns by switching to less volatile funds such as debt funds without interrupting the continuity of your investment. The switching feature is not available in mutual funds and those who get the jitters every time the market falls may take knee jerk reactions like canceling the SIPs and redeeming the units. This can lead to an irregular pattern of savings. 
  • Lock-in Period: The lock-in period in ULIP and higher surrender charges in the initial years ensures to a large extent that one does not fall prey to impulsive decisions. As mutual funds do not have any lock-in period or penalty (exit charges only in the first year), one may end up deciding to cancel/stop the SIP on the spur of the moment. This approach is wasteful and will not help in achieving financial goals. 

Tenure of Goals: For short terms goals or goals which fall due within five years it may be best to stick with mutual funds. For long term goals, you can go with either of the two.

Investment with Taxation Benefits: Those who are seeking an investment option which not only helps to accumulate a corpus but also provides taxation benefits, then ULIP may be the answer. Unlike ELSS, the policy is bought once while tax benefit can be enjoyed till completion of premium paying term.

Liquidity: If you are looking for a very liquid investment option then it is best to consider mutual funds.

Discipline in Savings: Financial experts suggest that one should invest in mutual funds via SIPs to develop a regular and disciplined approach towards savings. However, if you are an impulsive spender or have difficulty getting into a regular habit of savings, then among the two options ULIP may be more suitable to you as in a ULIP you need to pay premiums regularly to avoid policy lapsation. Also, the lock-in period and higher surrender charges initially may act as a deterrent to play truant and skip premiums. Thus, ULIP being a long-term product can help instill a habit of savings. On the other hand, mutual funds are flexible with regards to skipping or stopping SIPs and have no lock-in period. Thus, it may not be a good option for those who find it difficult to save.

Nature of Goal: If you are looking at creating a corpus for your children’s education or marriage needs, then probably a ULIP may be a good idea. Most of the ULIP child plans offer a waiver of premium (WOP) rider which gets activated if the life insured parent passes away during the policy tenure. Future premiums are waived off and paid for by the insurance company. Thus, the benefits envisaged while taking the policyholder and are paid when due thereby ensuring that the child’s future is not hampered due to the absence of the breadwinning parent. Also, immediately on the death of the life insured a sum assured/lumpsum amount is made available to the family.

Though mutual funds are also very good for creating a corpus for children, in case of death of the breadwinning parent further SIPs may not be paid and hence the creation of a healthy corpus may not be possible.

Mutual Fund or ULIP Which Generates More Returns

The returns from ULIP may be lower than mutual funds as insurance companies tend to be less aggressive in their investments as they need to promise the sum assured irrespective of how the investment performs (this does not imply that ULIP performance cannot beat mutual fund performance as returns depend on a host of factors such as quality of fund management, market conditions, etc). As mutual funds do not have to do this, they make more aggressive bets. Equity-oriented mutual funds have the potential for higher returns while debt-oriented mutual funds offer slightly lower returns.

Conclusion

Mutual funds and ULIP are different products, each with their own merits. It wouldn’t be right to call one superior over the other. Your goals, requirements and risk appetite should dictate which one is best for you. For some people, mutual fund investments plus a term plan may do well and for some others, it may be a ULIP. Even while opting for a ULIP, do ensure that you are adequately insured for 8-10 times your annual income plus liabilities by way of a term plan as the ULIP insurance coverage may not be sufficient to safeguard your family’s interests.

Sindu Ramankutty has 10 years of Life Insurance Operations and Customer Service experience. She has worked with two leading private life insurers. She has a PGDBM (General Management) from Narsee Monjee Institue Of Management Studies (NMIMS) Global Access, Licentiate from Insurance Institute of India (III) and ALMI from LOMA.