Why you may want to prefer Mutual Funds over ULIPs

Long gone are the days when investment in financial markets was limited to a few knowledgeable experts. With such a large section of retail investors eager to participate in the rising Indian markets, investment companies are making constant efforts to come out with products that are convenient for people to understand and invest in. The two most common products that fall in this category are mutual funds and ULIPs (Unit linked insurance plans). The general perception is that ULIPs are better than mutual funds because they offer dual benefit. Here, we will give you a few reasons to challenge this line of thought.

1. Mutual funds vs ULIPs: A mutual fund is a pool of money created by a professional fund management company by receiving contributions from individual retail investors, like you. The corpus so created is invested by the company in a variety of assets based on the mandate of the fund. Depending upon your investment objectives, risk appetite or market opinion, you may choose from among many funds with different mandates.

A ULIP, in contrast, is a product offered by insurance companies. It seeks to combine the benefits of a life insurance policy and investment in a fund. The investor pays a fixed insurance premium each month. A part of this premium is deducted upfront. Whatever he pays thereafter is invested in funds of his choice (debt, hybrid or equity funds), after the deduction of certain other charges. Additionally, ULIPs are tax-free under section 80C. For these reasons, they gained tremendous popularity earlier. However, now people have now started realizing the relative benefits of mutual funds.

2.Low cost structure: Investing in ULIPs involves multiple categories of charges. They include premium allocation charges, Administrative charges, Mortality charges and Fund management charges. This makes it more expensive to invest in ULIPs compared to mutual funds.

3. High liquidity: Mutual funds are highly liquid instruments, other than Equity Linked Saving Schemes (ELSS). You can buy or sell a mutual fund whenever you want to. Their price is calculated daily. Upon selling it you will receive the price for that day. Also, there is no minimum investment period in mutual funds. In contrast, ULIPs have limited liquidity. There is a generally a lock-in period, i.e. the minimum period for which you have to stay invested. So even if it is not performing well, you have to stick with it for a minimum period.

4. Greater options: Investors in ULIPs have only three options to choose among- debt, hybrid or equity funds. On the other hand, there are thousands of mutual funds to choose from for mutual fund investors. They can choose out of them based on their objectives and risk appetite.

5. No minimum investment requirement: The Insurance Regulatory and Development Authority of India (IRDAI) has recently proposed that ULIPs should be required to have a minimum of 25% of their portfolio invested in government bonds (G-secs). This will limit the ability of these instruments to generate huge profits. Government bonds are considered safer than other securities because investors are more confident that the government will be able to make the interest payment on these bonds. However, since G-secs pay lower interest than other securities, ULIPs will be able to generate lesser return. Mutual funds, in contrast, don’t have any such restrictions. They must only invest in the kind of assets that they have mentioned in the prospectus. Investors are free to choose what mutual fund they want to invest in.