This is a million dollar question asked by many investors. Before answering, why Mutual Funds are better than ULIPs, let us understand both these products closely.
What is a Mutual Fund?
A Mutual Fund is an investment product, where many investors are pooling their money to be managed by a professional Fund Manager. This allows you to invest small amounts as per your capacity and create good accumulation over the long term. A Mutual Fund is having a specialized team to take investment decisions based on the mandate given. The decision of where to invest will be taken by the Fund Manager of the Scheme. He is supported by a research team in identifying good Shares/Debt Schemes from the many schemes available in the market. Most of the Fund Houses will be having systems in place to do this function effectively. This will help the investors in getting professional help in investing.
There are different types of Mutual Funds:
- Equity Mutual Funds: In such funds, the majority of your investment will be in shares of selected companies.
- Debt Mutual Funds: Here, the investment will be mainly in Fixed Income instruments like Government Securities, Certificate of Deposit, Call Money Market etc.
- Balanced Mutual Funds: In such funds, the investment will be in a mixture of Equity and Debt Schemes as per the mandate of the Scheme. This will help the investor to diversify his portfolio in the same fund.
How much do you have to pay for the professional management of your money?
Of course, the Mutual Funds will not do this free for you. They are getting their income from the Fund Management charges deducted from your investment. There are clear guidelines regarding the management charges, a Fund can charge you. The percentage of charges is linked to the size of the Fund. Most of the Equity Funds in the country are charging anywhere in the range of 1.8 – 2.5% per year as Fund Management charges. In simple words, if you have an investment of Rs. 1 Lakh in a Fund, the Fund House will deduct around Rs. 2,500 for managing your Fund. This is reasonable for the effort they are taking in investing your money in good instruments.
Are there any hidden charges in Mutual Funds?
No, earlier there was an entry load in Mutual Funds. They used to deduct some amount from your investment and only the balance amount was invested. But SEBI banned the entry load and now, you need not pay any other charges other than the Fund Management charges in a Mutual Fund. This made Mutual Fund one of the most transparent and strictly regulated investment opportunities in India.
What is a ULIP?
Unit Linked Insurance Plan (ULIP) is a combination of a Life Insurance and Savings. In this case, you will get an insurance cover in addition to the investment returns. But is it worth buying ULIP instead of a Mutual Fund?
What are the charges in ULIPs?
There are many charges in ULIPs and there is no standardization in charges. Each ULIP is having its own charge structure and it is not transparent. Generally, the charges are under the following heads:
- 1. Premium Allocation Charges (PAC)
This will be the upfront amount deducted from your investment. This is high in the first year and less in the subsequent years. After the intervention of the regulator IRDA, now, this rate has come down. Still many of the ULIP policies are charging in the range of 5% to 15% in the first year and 2-5% in the subsequent years. This money mainly goes to pay commission to the agents.
- 2. Policy Administration Charges
This is the amount charged for the administrative expenses of the Insurance company. In most cases, the charges are fixed on a per policy basis. It can be in the range of Rs. 20 – Rs. 100 per month. In some cases, this charge will increase by a fixed percentage like 5% every year. In some cases, you can see this as a percentage of the premium. This will be a high amount and is deducted on a monthly basis. In a long-term policy, this charge can bring your returns down.
- 3. Mortality Charges
This is the charge for providing the Life Insurance cover. This charge will be linked to your age and will increase with your age.
- 4. Fund Management Charges
This is the amount charged by the company for managing your Fund. This is similar to the Fund Management charges in Mutual Fund.
Impact of these charges in ULIPs
With the combined effect of the abovementioned 4 charges, the pace of growth of your investment will be slow in ULIP compared to a Mutual Fund. There is no transparency and standardisation in many charges across various ULIPs which confuse the policy holder. There are ULIPs, where there is no premium allocation charges, but with a high policy administration charges. The Insurance company continues to charge these recurring charges, even if you stop the premium after paying for some years. This can reduce your accumulation, if the investment is not growing well.
No Escape Route?
If your Mutual Fund is not performing well, you have the option to close it any time and reinvest in a better Fund. Such options are not there in a ULIP. Once you pay the premium for the first year, you are locked into the scheme for at least 5 years depending on the plan. If you want to opt out in the initial years, there are discontinuance charges.
Why Mutual Funds are better than ULIPs?
By now, I am sure you have the answer. The huge and recurring charges under various heads make a ULIP unattractive from the investment angle. The small Life Insurance cover added in ULIP is not a valid reason to buy it instead of a Mutual Fund.
Will you go for ULIPs?
It is in your interest to opt for Mutual Funds instead of ULIPs. Also, buy a Term Policy of adequate value to cover your life. Along with a Term Policy, a Mutual Fund is much better compared to any ULIP any time.