Investors often get confused between choosing mutual funds that invest in varied instruments and ULIP schemes that offer the dual advantage of insurance cover and returns on investments. Both the options are suitable for achieving your long-term goals like buying a house or saving for your retirement through wealth creation via investment in equity markets and other financial instruments. But the two types of investment schemes differ from each other in terms of the returns and benefits offered. They also cater to the requirements of investors with different investment goals and returns.
Here, we talk about the similarities and the differences between mutual funds and ULIPs, along with their meaning for the investors.
Understanding Mutual Funds and ULIPs
Mutual funds are investment schemes wherein the asset management company invests the funds collected from investors in different types of instruments, like equities, bonds, money market instruments, and commodities. The performance of these mutual fund schemes is dependent on the performance of the underlying instruments in which they have invested. The investment is done by professional fund managers who have the necessary expertise and knowledge about markets and investments. Some mutual funds invest based on a pre-determined strategy and certain goals. Mutual funds can be categorised into equity funds, debt funds, balanced funds, growth funds, income funds, liquid funds, and money market funds, depending on their investment goals and the type of instrument in which they invest.
In contrast, a Unit Linked Insurance Plan or ULIP is a life insurance plan that utilises a portion of the premium paid by the policyholders towards investment in different instruments like equity, debt, bonds, or a combination to create wealth over the long term. ULIP policies come with an assured maturity cover, irrespective of the returns earned on the investments made under them.
How Are They Similar?
- Returns Dependent on Markets– The returns from both ULIP schemes and mutual funds depend on the type of instrument in which the investor’s money is invested. Investors have the option to choose schemes or investment plans based on their risk appetite and the expected returns. Investors can use a ULIP return calculator to decide what amount to invest in which investment category for earning specific returns. There is no guarantee of any minimum investment returns in both cases.
- Transparency-Mutual funds have to mandatorily provide detailed information about their investment portfolio, asset allocation, active fund managers, and the fees being charged. The regulatory authority for the insurance segment, IRDAI, has also made it compulsory for insurance companies to provide upfront information on the fund allocation.
- Fees– Investment in mutual funds involves some charges relating to the professional management of the fund and its operations. Some mutual funds also charge an exit fee or a charge for leaving the scheme early. Similarly, ULIP investments involve a charge relating to premium allocation, fund management, administration, partial withdrawal, or early surrender of a scheme.
What Makes ULIPs Different From Mutual Funds?
- Objective-The two instruments differ in their objective, with mutual funds being a pure investment product, while ULIP being a life insurance product that comes with an additional feature of market-linked investment.
- Returns on Investment– The investment returns from ULIPs are lower than those offered by mutual funds. This is because ULIPs promise a fixed maturity amount to secure the financial future of the policyholder, irrespective of the returns from investments. In the case of mutual funds, the returns vary as per the investments being made.
- Lock-in Period-Another major difference between the two products is that ULIPs have a lock-in period of five years, while most open-ended mutual fund schemes, except for ELSS (they have a lock-in period of three years) have no lock-in period.
- Tax Benefits– Investment in and returns earned from ULIPs are tax-free under section 80C and Section 10D, respectively. Returns from mutual funds attract long-term capital gains and short-term capital gain taxes, depending on the holding period. Only ELSS or Equity-Linked Savings Schemes are eligible for tax deduction under Section 80C.
- Liquidity- Mutual fund investments can be offloaded at any time, except in the case of ELSS, which comes with a lock-in period of three years. Investment in ULIPs cannot be withdrawn before the end of the five-year lock-in period.
Once the similarities and the differences between the ULIP plans and mutual funds are known, the decision becomes easy. Mutual fund investments are suitable for investors who have already taken a life insurance policy or a term insurance plan. Another reason to choose mutual funds is when an investor is looking for high liquidity (the option to offload investments at any time) and only returns. However, if an investor is looking to invest in a plan that offers both investment returns and insurance cover, ULIP is the best option. Investment in ULIP plans is also eligible for tax exemption, making it suitable for investors looking to save taxes.