How to understand the basics of ULIPs as a financial lesson

Posted by amrina alshaikh on May 20th, 2022

A recent report suggests that the number of Indians investing in mutual funds and exchange-traded funds has grown by more than 1,500 per cent in the past decade. That’s a growth rate that’s almost five times the pace at which the Indian mutual fund industry grew during the same period. The appeal of mutual funds is undeniable – they offer the opportunity to invest in a basket of stocks and bonds, with the potential for higher returns than you can get by investing directly in individual stocks.  One of the primary reasons for this surge in interest in mutual funds is that they’re offered by many so-called ‘index mutual funds’ (also known as ‘open-ended’ or ‘unit-liability’ funds). These funds operate much like traditional mutual funds – you invest in them the same way, you receive their annual or semiannual statements in the same way, and the underlying investments of the fund are the same as in a traditional mutual fund. However, there are key differences between these two types of funds as well. Here’s a quick guide to the basics of ULIPs, including how they work, the risks involved, and other considerations for your personal financial planning.

What are ULIPs and How They Work

ULIPs are a ‘forced-savings’ product. You invest your money, and the fund manager invests it in stocks, bonds, or other investments on your behalf.  This is where the first key difference between ULIPs and mutual funds comes into play – with a traditional mutual fund, you can choose when to sell your shares and withdraw your money from the fund. In contrast, ULIPs are typically structured so that withdrawals are not permitted until after a specified time. This time is known as the ‘lock-in’ period; if you try to withdraw before this time has elapsed, you could be penalized for early withdrawal.

The Pros and The Cons of ULIPs

ULIPs offer some useful benefits that many traditional mutual funds don’t provide. Many people purchase ULIPs to reduce the risk to their investment portfolio. Traditional mutual funds usually invest in a mix of stocks, bonds, and other securities, but ULIPs only invest in equity-linked and equity-oriented products. This means that if you buy a ULIP, your investments are less likely to decline in value during a market downturn. Additionally, ULIPs have higher insurance coverage than traditional mutual funds. Most ULIP policies offer coverage for the first Rs 5 lakhs if the investor is killed or permanently disabled. Some policies also offer coverage for death due to natural causes, wrongful death, and accidental death under specific circumstances. Traditional mutual fund policies typically cover no more than Rs 1 lakh in these scenarios.

One of the primary drawbacks of ULIPs is that they carry a high cost when compared to traditional mutual funds. In addition, you’ll need to pay an annual expense fee to keep your ULIP in force. Unlike traditional mutual funds (or exchange-traded funds), they don’t offer a fixed return or guarantee. Instead, they offer what’s called ‘guaranteed equity returns’ which may range between 8%-12%.

Should You Invest in ULIPs?

If you’re going to invest in ULIPs, be sure that you have a personal financial adviser or financial planner on hand. A financial adviser can help you determine the best way to generate good investment returns, while also helping you understand any associated risks.

What are the risks of investing in ULIPs?

Investing in ULIPs is not without its risks – it’s important for anyone considering investing to be aware of those potential risks and to take steps to mitigate them where possible.

Is ULIP Investing Right for You?

In many ways, ULIPs are a great idea. They offer tax efficiency, they’re a way to diversify your portfolio without committing to individual stocks or bonds, and they offer the potential for higher returns than you can get by investing directly in individual stocks. The key is making sure that they’re right for you and your financial goals. If what you care about most is capital appreciation, then ULIP investing may not be the best choice for you. If what you care about most is accumulating cash value and benefits that will be paid out on maturity, then ULIPs might be an excellent choice for you. If your goal is to accumulate cash value and benefits that will be paid out on maturity – like those offered by ULIPs - then it might not make sense to invest in mutual funds with high liquidity risks and lower yields. For these investors, ULIPs are an excellent option because of the cash flow benefits they provide; these investors are more interested in getting their money back as opposed to having it grow over time. ULIPs have also become popular among retirees who want a way of generating regular income without having to worry about market volatility. However, it’s important to consider how well your new income would cover expenses during periods when markets do poorly.