Sangeeta,42,walked into my office with a newspaper in her hand. The paper had a story on unit-linked insurance plans (Ulips). Should I invest in ulips now that the controversy surrounding them has settled? she asked.
I smiled. The new regulatory amendments to the ulip schemes are expected to make them more investor friendly. But to understand whether you should invest in ulips or not,let us first understand what is a ulip?, I said.
What are ulips?
Ulips are financial products that offer the convenience of both – an insurance policy and a mutual fund. Conceptually,this appears like a good product as it offers the comfort of an insurance policy,which will protect you against any unfortunate event,and at the same time,invest a part of your money. Therefore,such a policy will protect you and also take care of your financial goals such as a comfortable retirement, I said.
Are there any other options? she enquired.
Yes. Instead of paying for a ulip policy,you can buy life insurance through a term plan and make investments through equity mutual funds. This arrangement is likely to benefit you more. A term plan is a pure life insurance policy that offers only insurance cover. It can also be purchased at a very low cost to provide a large sum assured. For example a 30-year old could buy a life insurance cover by paying as little as Rs 2,500 per annum. Rest of the savings can be pumped in various instruments like mutual funds,PF or PPF accounts. The allocation between equities and provident funds,however,would depend on the investors risk profile. I said.
But this option appears far more cumbersome that just subscribing to a ulip, Sangeeta said.
Advantages of Ulips
That is true. Ulips have some other advantages too. Lets examine some of them. Ulips now offer a lock-in period of 5 years during which you cannot withdraw your capital. Since wealth is created through long-term investments in stock markets,this clause will discourage investors to withdraw money from ulips. As a result,it makes investors remain invested and enjoy the compounding effect of money and create wealth. Ulips also use a part of your contribution to provide you with an insurance cover. Since it provides an insurance cover and is sold by insurance companies,the lay person feels a sense of comfort of having bought an insurance policy. Investing in equities directly or via equity mutual fund does not provide the same degree of comfort for most people, I said.
To sum up,ulips offer a feeling of safety and help investors remain invested. If this is so,why will anyone choose to use the more complicated route of buying a term plan,equity fund and PPF?, asked Sangeeta.
Disadvantages of Ulips
Good question, I replied. First,there are many financially literate investors who are not bothered by market fluctuations and hold stock investments for the long term. Therefore,they find little benefit in the lock-in period that ulips offer. Second,ulips have high expenses in terms of marketing and distribution costs. Front-loading of costs and high charges eat into the returns. Third,ulip investors lack the freedom that comes with direct equity and mutual fund investments. One can buy or sell an equity fund at any time.
Consider this. Salim,34,had bought a term plan to cover his life and also invested in equities with the long-term view. Favourable market conditions swelled his capital to almost three times within three years. He thought of registering his profits and sold a part of his portfolio to buy a plot of land for his brother. He could take this decision as he was not bounded by any contract. However,had he invested in ulips,he would not have been able to liquidate his investments. This means that he had more money to invest in other avenues and therefore his capital had grown more.
So ,if you are financially savvy or have a financial advisor who you trust,it is better to go in for a term plan,equity funds and PPF, Sangeeta said.
That is correct. Ulips are meant for investors who have limited exposure to the world of investing. For financially-savvy investors,there are better options, I said.
Sangeeta needed a few days to decide if she was a financially-savvy investor or not. She knew that if she applied her mind she could certainly be one. She said goodbye and left.
The author is a Pune-based certified financial planner.