You would surely be aware that Long Term Capital Gains (LTCG) on your equity investments (whether direct or through mutual funds) are now taxable. With effect from April 1, 2018, LTCG of more than Rs.1 lakh will be taxed @10%.
However, long term capital gains on Unit Linked Insurance Plans (ULIPs) continue to remain exempt from any such tax.
Hence, it would be natural for equity investors to prefer ULIPs over Mutual Funds (MFs).
Beware! This could turn out to be a bad choice.
Why? Let's explore:
In terms of investment, both mutual funds and unit linked insurance plans invest in the SAME stock markets.
Therefore, it stands to reason, that the potential to earn "pre-cost" returns from both the products is also the SAME.
But ULIP is an insurance plan. So, apart from various costs (discussed later) involved in managing the investment whether thru' ULIP or MF, there is an added cost in ULIPs towards providing you an insurance cover... known as mortality charges.
It is but obvious that if you don't need insurance cover, you should not invest in ULIPs.
Why bear the unnecessary burden of mortality charges that will surely bring down your overall returns? Even after paying the recently introduced LTCG Tax on MF returns, you would be better off with MFs than ULIPs.
But what if you also require an insurance cover?
Should you then invest in a ULIP, instead of buying a MF + Term Plan combo?
The answer is NO.
The reasons for this are many:
Reason No. 1 : High cost structure
Firstly, in mutual funds there is a single cost known as the 'fund management expenses'. This simplicity is lacking in ULIPs; where you will have to add up a few costs, such as fund management charges, policy administration charges etc., to work out the total cost charged to you.
Secondly, you will find that the total costs in managing the investment in ULIPs (excluding the mortality charges, for like to like comparison) are generally higher than the charges in case of MFs.
This is definitely going to badly affect your returns in ULIPs when compared to MFs.
So much so that, even after the new 10% LTCG Tax, MFs will deliver higher returns than ULIPs.
Hence, unless you find some ULIPs that are as cost competitive as MFs, it is best to avoid ULIPs. Assuming similar fund management, you can never make more returns — from the same market — by paying more costs.
Reason No.2 : Up-front cost deduction
In mutual funds, the entire amount that you pay to buy the units, is invested in the market. There is NO entry load. There is no cost deducted upfront.
ULIPs normally have a premium allocation charge. This is deducted as soon as you pay the premium. Only the net amount remaining thereafter is invested in the market.
This, you can well appreciate, will make difference to the returns generated, even if both ULIP and MF invest in the same set of stocks in the same ratio (say for example an Index MF or an Index ULIP). It is always better to invest, earn and pay later, rather than pay, invest and then earn.
Again, MFs have a clear edge over ULIPs.
Reason No.3 : Lock-in
Mutual funds have no lock-in. At most, there may be an exit load if you redeem the investment within one year or so. Whereas, in ULIPs, your money is locked-in for 5 years.
Even the tax-saving mutual funds (i.e. Equity Linked Savings Scheme or ELSS), have a lock-in period of only 3 years.
Sure, you should ideally hold your equity investment for long term. But still, given the uncertainties in life, as far as possible it is good to have the flexibility with regards to your investments. You can change your mutual funds, if any of them is under-performing. You can take out money in case of emergencies.
Reason No.4 : Concentration risk
To buy a meaningful insurance cover of say Rs.50 lakhs to Rs.1 crore, you will have to pay an exorbitantly high premium of Rs.5-10 lakhs in case of ULIPs. Whereas a term plan will give you the same cover at a much (much) lower premium.
Even otherwise, in ULIPs most people pay a typical premium of around Rs.20,000 to Rs.50,000.
As a result
a) You are committed to make such a huge saving year after year. With a MF + Term Plan combo, you have the flexibility to vary your investment year on year, depending on your financial conditions.
b) This huge amount is invested in just one fund, thereby exposing you to very high concentration risk. With a MF + Term Plan combo, you have the flexibility to create a well-diversified and well-balanced portfolio — spread across different types of schemes and different AMCs.
Diversification is one of the most critical requirements, if you wish to make money from equity.
Reason No.5 : Surrender Costs
If you sell your equity mutual fund units after one year, there are normally no charges at all.
If you surrender your ULIP within 5 years, you have to pay certain policy surrender charges (up to a max of Rs.6000). But that's not important.
What's more important is that you don't get this money back immediately. You have to wait for 5 years for it. Plus, for the remaining period i.e. from the date of surrender till the 5 years of policy are complete, you get only the savings account interest on the surrender amount.
In short, surrendering a ULIP within 5 years in going to cost you a bomb. This seriously restricts your ability to change your investments with time and circumstances.
Reason No.6 : Cumbersome portfolio tracking
In mutual funds, NAV that you see is minus the expenses. So, NAV is what you get in hand. Number of units you hold multiplied by the Net Asset Value is the value of your investment. If you sell, this is the amount you receive (less exit load, if any; usually nil after one year of holding period). As simple as that.
Whereas in ULIPs, various charges such as policy administration charges, fund management charges etc., are recovered by cancelling the corresponding number of units.
It is difficult to keep track of your units, that reduce month after month due to cancellations. So, it is comparatively more difficult to monitor your ULIP investments as compared to MF investments.
Warning: The sales pitch of any ULIP plan will henceforth always talk about its "tax-free" nature. It will always highlight the 10% tax advantage vis-a-vis mutual funds. If you are a smart investor, you won't be lured by this just one small advantage.
You simply can't ignore the many disadvantages of ULIPs vis-a-vis the MFs.
As a package in totality, MF + Term Plan combo will still outperform,outclass and outshine the ULIPs.
However, long term capital gains on Unit Linked Insurance Plans (ULIPs) continue to remain exempt from any such tax.
Hence, it would be natural for equity investors to prefer ULIPs over Mutual Funds (MFs).
Beware! This could turn out to be a bad choice.
Why? Let's explore:
In terms of investment, both mutual funds and unit linked insurance plans invest in the SAME stock markets.
Therefore, it stands to reason, that the potential to earn "pre-cost" returns from both the products is also the SAME.
But ULIP is an insurance plan. So, apart from various costs (discussed later) involved in managing the investment whether thru' ULIP or MF, there is an added cost in ULIPs towards providing you an insurance cover... known as mortality charges.
It is but obvious that if you don't need insurance cover, you should not invest in ULIPs.
Why bear the unnecessary burden of mortality charges that will surely bring down your overall returns? Even after paying the recently introduced LTCG Tax on MF returns, you would be better off with MFs than ULIPs.
But what if you also require an insurance cover?
Should you then invest in a ULIP, instead of buying a MF + Term Plan combo?
The answer is NO.
The reasons for this are many:
Reason No. 1 : High cost structure
Firstly, in mutual funds there is a single cost known as the 'fund management expenses'. This simplicity is lacking in ULIPs; where you will have to add up a few costs, such as fund management charges, policy administration charges etc., to work out the total cost charged to you.
Secondly, you will find that the total costs in managing the investment in ULIPs (excluding the mortality charges, for like to like comparison) are generally higher than the charges in case of MFs.
This is definitely going to badly affect your returns in ULIPs when compared to MFs.
So much so that, even after the new 10% LTCG Tax, MFs will deliver higher returns than ULIPs.
Hence, unless you find some ULIPs that are as cost competitive as MFs, it is best to avoid ULIPs. Assuming similar fund management, you can never make more returns — from the same market — by paying more costs.
Reason No.2 : Up-front cost deduction
In mutual funds, the entire amount that you pay to buy the units, is invested in the market. There is NO entry load. There is no cost deducted upfront.
ULIPs normally have a premium allocation charge. This is deducted as soon as you pay the premium. Only the net amount remaining thereafter is invested in the market.
This, you can well appreciate, will make difference to the returns generated, even if both ULIP and MF invest in the same set of stocks in the same ratio (say for example an Index MF or an Index ULIP). It is always better to invest, earn and pay later, rather than pay, invest and then earn.
Again, MFs have a clear edge over ULIPs.
 |
| If you read the fine print, Mutual Funds still outperform the ULIPs. |
Reason No.3 : Lock-in
Mutual funds have no lock-in. At most, there may be an exit load if you redeem the investment within one year or so. Whereas, in ULIPs, your money is locked-in for 5 years.
Even the tax-saving mutual funds (i.e. Equity Linked Savings Scheme or ELSS), have a lock-in period of only 3 years.
Sure, you should ideally hold your equity investment for long term. But still, given the uncertainties in life, as far as possible it is good to have the flexibility with regards to your investments. You can change your mutual funds, if any of them is under-performing. You can take out money in case of emergencies.
Reason No.4 : Concentration risk
To buy a meaningful insurance cover of say Rs.50 lakhs to Rs.1 crore, you will have to pay an exorbitantly high premium of Rs.5-10 lakhs in case of ULIPs. Whereas a term plan will give you the same cover at a much (much) lower premium.
Even otherwise, in ULIPs most people pay a typical premium of around Rs.20,000 to Rs.50,000.
As a result
a) You are committed to make such a huge saving year after year. With a MF + Term Plan combo, you have the flexibility to vary your investment year on year, depending on your financial conditions.
b) This huge amount is invested in just one fund, thereby exposing you to very high concentration risk. With a MF + Term Plan combo, you have the flexibility to create a well-diversified and well-balanced portfolio — spread across different types of schemes and different AMCs.
Diversification is one of the most critical requirements, if you wish to make money from equity.
Reason No.5 : Surrender Costs
If you sell your equity mutual fund units after one year, there are normally no charges at all.
If you surrender your ULIP within 5 years, you have to pay certain policy surrender charges (up to a max of Rs.6000). But that's not important.
What's more important is that you don't get this money back immediately. You have to wait for 5 years for it. Plus, for the remaining period i.e. from the date of surrender till the 5 years of policy are complete, you get only the savings account interest on the surrender amount.
In short, surrendering a ULIP within 5 years in going to cost you a bomb. This seriously restricts your ability to change your investments with time and circumstances.
Reason No.6 : Cumbersome portfolio tracking
In mutual funds, NAV that you see is minus the expenses. So, NAV is what you get in hand. Number of units you hold multiplied by the Net Asset Value is the value of your investment. If you sell, this is the amount you receive (less exit load, if any; usually nil after one year of holding period). As simple as that.
Whereas in ULIPs, various charges such as policy administration charges, fund management charges etc., are recovered by cancelling the corresponding number of units.
It is difficult to keep track of your units, that reduce month after month due to cancellations. So, it is comparatively more difficult to monitor your ULIP investments as compared to MF investments.
Warning: The sales pitch of any ULIP plan will henceforth always talk about its "tax-free" nature. It will always highlight the 10% tax advantage vis-a-vis mutual funds. If you are a smart investor, you won't be lured by this just one small advantage.
You simply can't ignore the many disadvantages of ULIPs vis-a-vis the MFs.
As a package in totality, MF + Term Plan combo will still outperform,outclass and outshine the ULIPs.
