ULIPs vs Mutual Funds: Which One Should You Choose to Invest for Your Financial Goals?

In this article, we will compare Mutual funds Vs ULIP to help you select the most suitable option for your needs.

Let us first understand the meaning of mutual funds and ULIPs...

What are Mutual Funds?

A Mutual Fund is an investment vehicle in which the money pooled from investors is invested in a variety of instruments such as equity and debt, depending on its pre-defined investment objective. These funds are regulated by the Securities and Exchange Board of India (SEBI).

The firm that manages the investments is termed as the Asset Management Company (AMC). The AMC employs various employees in different roles who are responsible for servicing and managing investments.

The AMC offers various products (schemes) in mutual funds, which are structured to benefit and suit the requirements of diverse investors. Every scheme has an investment objective that it aims to achieve through judicious management of the portfolio.

Mutual Funds issue units to the investors in accordance with quantum of money they invest. Investors of mutual funds are known as unitholders.

The combined securities and assets the mutual fund owns are known as its portfolio, which is managed by qualified and experienced investment professional fund managers. Each unit an investor holds represents a portion of the portfolio. The value of the units held fluctuates in line with the underlying value of the portfolio. The value of each unit is represented by the Net Asset Value (NAV) of the mutual fund.

Mutual funds are broadly three types: equity, debt, and hybrid. Within each of these categories, one can find various sub-types identified based on different parameters such as the market segment, investment style, duration, and risk factor, etc.

Mutual Funds can also be classified based on whether they are actively managed or passively managed.

Mutual Funds do not carry lock-in period (barring ELSS and Solution-oriented Funds) and can be redeemed as per one's requirement.

What are ULIPs?

Unit-linked Insurance Plans (ULIPs) are hybrid products that combine insurance policy with investment. Thus, ULIP provides you the opportunity to create long-term wealth and get life insurance cover through a single product. These products are offered by life insurers and are regulated by the Insurance Regulatory and Development Authority of India (IRDAI).

Since these products are offered by insurers and due to the inbuilt insurance component, the payment made are known as a premium. A portion of your premium goes toward providing life insurance coverage while the rest is invested in the asset class of your choice: equity, debt, or hybrid. ULIPs may offer multiple options within each product and investors have the flexibility to switch between these options. In the event of the death of the policyholder during the policy term, the nominated beneficiaries will receive the sum assured as a death benefit.

Policyholders have the option to decide the percentage of premium that should be allocated to life insurance coverage and the percentage to be invested. The premium can be paid annually, semi-annually, or monthly, depending on the premium payment term. ULIPs may also offer the flexibility to choose the number of premium-paying years as per the investor's preference.

Similar to mutual funds, ULIPs have fund managers who look after the investments. Moreover, much like mutual funds, units are allocated to you at the Net Asset Value (NAV) of the respective fund, which serves as the benchmark for calculating market-linked gains or losses. ULIPs have a lock-in period of 5 years and thus require a long-term investment horizon.

Mutual Fund vs ULIP: Which is Better?

1) Tax Benefits

Premium paid towards ULIPs is eligible for a tax deduction of up to Rs 1.5 lakh in a financial year under Section 80C of the Income Tax Act, 1961. Among Mutual Funds, only investments made in ELSS (Tax Saving Mutual Funds) are eligible for tax deductions of up to Rs 1.5 lakh annually.

Notably, the lock-in period in ELSS is lower at 3 years, compared to 5 years in the case of ULIPs.

2) Return on Investment

Mutual Fund being a pure investment plan can potentially generate higher return on investment. In the case of ULIPs returns may be impacted due to the added insurance cost and other related charges.

3) Insurance cover

ULIP provides insurance cover to policyholders along with wealth creation opportunity. While mutual funds do not offer insurance cover, investors looking for life cover can purchase Term Plan as a separate product.

Term Plans are a more cost-efficient manner of protecting your family against unforeseen events as you get higher insurance coverage for the premium paid compared to ULIPs. Life cover offered under ULIPs may not be adequate to fulfil the needs of your family in the case of the death/disability of the breadwinner.

[Read: Your Definitive Guide to Buy Life Insurance]

4) Early exit

In the case of ULIPs, if the policyholder stops paying premiums or opts for an early exit, the insurer may impose penalties and the policyholder may also lose out on various product-related benefits such as market-linked returns, life cover, and tax benefits.

In the case of Mutual Funds even if the unitholders stop/pause their SIP investment, they continue to earn market-linked returns on accumulated corpus. However, exit load may apply if the units are redeemed within a certain period (varies from scheme to scheme). In the case of ELSS there is no provisions to make premature exit.

5) Asset Allocation

The flexibility to choose schemes as per one's asset allocation strategy is where mutual funds truly outscore ULIPs. Mutual Fund investors have the freedom to choose from a wide range of asset classes viz. equity, debt, gold, international equities, etc. and the sub-categories within them. They also have the option to choose from investment styles - growth, value, blend, as well as investment strategy - active or passive, allowing them the flexibility to tailor the portfolio as per their risk appetite investment horizon, and financial goals.

While ULIPs too offer equity, debt, and hybrid options, the choices may be relatively restricted, which may hinder the implementation of an effective asset allocation strategy.

Besides, the construction of ULIPs can be complicated to comprehend as it involves numerous fees and charges such as premium allocation charges, policy administration charges, fund management charges, mortality charges, and guarantee charges, among others. These charges can result in higher cost and eat into the overall returns.

To conclude:

To maintain clarity and efficiency, it is advisable to keep insurance and investment needs separate. For wealth creation needs, a portfolio of carefully selected mutual funds can be a better tool due to their simpler construction and the diversity of the options they offer. They also offer better transparency in terms of portfolio composition, making it easier for investors to compare schemes. For insurance coverage, a pure-term plan is recommended as it offers better protection at reasonable pricing.

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DIVYA GROVER is the co-editor for FundSelect, the flagship research service of PersonalFN. She is also the co-editor of DebtSelect. Divya is an avid reader which helps her in analysing industry trends and producing insightful articles for PersonalFN’s popular newsletter – Daily Wealth letter, read by over 1.5 lakh subscribers.
Divya joined PersonalFN in 2019 and has since then used stringent quantitative and qualitative parameters to analyse funds to provide honest and unbiased research to investors. She endeavours to enable investors to make an informed investment decision and thereby safeguard their wealth.

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.