ULIP vs Mutual Funds: Which is a better investment?

The investing world has a plethora of investments available in the market. Of all the investments, the two most popular ones among retail investors are mutual funds and Unit Linked Investment Plans (ULIPs). Although very different, these two compete for a significant portion of your wallet. So, let’s compare ULIP vs. mutual funds and understand the advantages and limitations of each.

What is a ULIP?

ULIP is Unit Linked Investment Plan – a financial instrument that combines life insurance with investments. The scheme allows you to avail insurance benefits while helping you accumulate wealth for your long-term goals. When you pay a premium, it is divided into two parts: one goes towards the insurance premium, and the other goes towards various financial instruments such as stocks, bonds, and government securities.

Features of ULIP

Life cover: ULIP allows you to secure the financial future of your family by providing term insurance. You can select the sum insured based on your need.

Investment: Apart from providing you insurance, the scheme allows you to invest in financial securities, much like mutual funds. You can select the type of plan you invest in, and you have the flexibility to switch between funds to match your changing needs.

Premium paying options: ULIPs have multiple premium paying options, such as single, monthly, half-yearly, or yearly. You can choose the one that will match your resources and goals the best.

Top-ups: As your income increases, you can increase your premium payments as well through the top-up option. This top-up will be an additional investment over the existing investment.

Partial withdrawal: If you need money to fund an emergency, you can partially withdraw from your ULIP plan after five years. However, there is a limit on the number of withdrawals and the amount you can withdraw.

Advantages of ULIP

Dual benefits: ULIPs provide the dual benefits of an insurance policy and an investment. With just one financial instrument, you can fulfil both your insurance and investment needs.

Tax exemption: The premium you pay for your ULIP plan qualifies for tax deduction under Section 80 C of the Income Tax Act, 1961. The maturity benefit is also tax-free under Section 10 (10 D).

Fund switching: In ULIPs, you can not only choose the type of funds you want to invest in, but you can also switch between funds without any additional charges or costs. This feature of ULIPs will help you switch when your goals are nearing or the market is very volatile. In such cases, you can switch from equity to debt and then again back to equity.

Limitations of ULIP

Expense ratio: ULIPs have a lot of expenses associated with them. They charge administration charges, fund management charges, switch charges, surrender charges, mortality charges, premium allocation and withdrawal charges from you. They deduct all these charges before investing in a fund of your choice. Hence, your total investment comes down by a substantial amount.

Lock-in period: ULIPs have a lock-in period of five years. Hence, you cannot withdraw your money before this tenure. Even if you surrender your policy before five years, you will have to wait until five years to get back your money.

Market volatility: ULIPs invest in marketable securities and hence are exposed to market volatility. In the initial years, the return from them is low or even negative. However, in the long term, they give decent returns.

Complex instrument: ULIPs are a complex instrument as they are both an insurance and investment product. It can get difficult to keep track of the premium and NAVs (net asset value) of the fund, along with switching, redirecting, and investing decisions to maximise your gains.

What is a mutual fund?

Mutual funds are the most popular financial instruments. They pool money from several investors who have a similar objective and invest in marketable securities such as shares, bonds, debentures, and government securities. There are various types of mutual funds based on market capitalisation, asset type, duration, and risk factors. Hence, investors have a wide variety to choose from.

Mutual funds are managed by professional fund managers who decide the asset allocation and the securities for the fund after doing thorough research. They strive to make profits for the investors, which is automatically reflected in the NAV of the fund. For the service they provide, they charge a small fee called the expense ratio.

The expense ratio varies across different funds, and so do the portfolio and the returns.

Features of mutual funds

Mode of investment: Mutual funds allow you to invest in lumpsum or in instalments through SIP (Systematic Investment Plan). Even in SIPs, you can choose for monthly or weekly SIPs.

Affordability: The minimum investment in mutual funds is very low, and you can start a SIP with just Rs 100 per month.

Wide variety: Mutual funds can be categorised into several types based on the asset class, market capitalisation, and theme. Investors can choose from this widespread, based on their goals, and risk tolerance levels.

Fund management: Professional and experienced persons manage mutual funds’ portfolios. They do thorough market research before selecting securities for the portfolio.

Advantages of mutual funds

Liquidity: Mutual funds are very liquid investments. You can withdraw your money anytime you want without restrictions, except for ELSS (tax saving funds). Depending on the type of mutual fund, it can take one to three working days for the money to get credited into your account.

Diversification: Mutual funds invest in a wide range of securities spread across different asset classes and risk categories. By investing in just one fund, you can get access to a bunch of securities.

Convenience of investing: With the widespread popularity of mutual funds, investing in them has become very convenient. You don’t have to go to an asset management company’s (AMC) office to invest in mutual funds. There are several apps through which you can invest in mutual funds in the comfort of your home.

Regulated by SEBI: Mutual funds are regulated by the Securities and Exchange Board of India (SEBI). SEBI has laid out rules and regulations for mutual fund companies to ensure investor’s interests are protected.

Tax saving: Investment in ELSS or equity-linked saving schemes is eligible for tax deduction under Section 80C of the Income Tax Act, 1961. So, you can invest Rs. 1.5 lakhs in ELSS funds and get a tax deduction on the same.

Transparency: Mutual funds are mandated to release all necessary fund information to the investors. The fund’s scheme information document (SID) is available on its website, which includes data such as holdings, fund manager, and expense ratio. The NAV of the fund is published daily on the fund’s website. 

Returns: Although mutual funds don’t guarantee returns, over the long term, they can help accumulate wealth to fulfil your financial goals through the power of compounding.

Disciplined investing: Through SIP, you can inculcate the habit of financial discipline. By investing every month, you can accumulate enough money to fulfil all your needs. Moreover, by automating your investments, you will never forget to invest.

Limitations of mutual funds

Exit load: Mutual funds have an exit load of 1% if withdrawn before completing a year of investment.

Market volatility: Since mutual funds invest in marketable securities, they are exposed to market volatility in the short term.

Risk of over-diversification: Mutual funds invest in diverse securities. There is a chance that the funds you invest in have the same securities, which will lead to over-diversification and might pull down the actual return of your portfolio.

Difference between ULIPs and mutual funds

ULIP vs Mutual Funds: Which is a better investment?

Both mutual funds and ULIPs are marketable securities that are exposed to market volatility. However, both have their own set of advantages and limitations. ULIPs are better if you are looking for insurance and investment and want tax benefits. On the other hand, mutual funds are better if you have short and long-term goals and you aim to diversify your portfolio with low investment.

Hence, before choosing, you must be clear with your goals, investment horizon, and risk tolerance level. You must always choose an investment based on your resources and goals and not based on what others suggest. This is because what is best for someone else might not be the right choice for you.

Frequently asked questions

Which is better, ULIP or mutual fund?

Both ULIP and mutual funds are financial instruments that can help fulfil financial goals. However, they fulfil separate financial needs. If you need insurance along with investment, ULIPs are better. In case you need investments for short and long-term goals, then mutual funds are your pick.

Why SIP is better than ULIP?

SIP in mutual funds is considered better than a ULIP policy because there are no additional hidden charges. Moreover, it is a pure investment product, and if you invest Rs 5,000, the entire amount will be used for investment. In the case of ULIPs, a part of it will go towards the premium and mortality charges. SIPs also offer higher returns than ULIPs. This could be why SIPs are a preferred investment to ULIPs.

Is ULIP tax-free?

Investment up to Rs 1.5 lakhs in ULIPs is tax-free under Section 80C of the Income Tax Act, 1961. Moreover, the maturity benefit is also tax-free under Section 10 (10D).

Is ULIP risk-free?

ULIPs invest in marketable securities such as equities, bonds, and debentures. They are not risk-free as they are exposed to market volatility. Moreover, they do not guarantee returns as well.

Can I withdraw from ULIP after five years?

Yes, you can withdraw from your ULIP investment after five years, as the lock-in period will be completed. However, you can only withdraw if you paid all the instalments, and only 10-20% of the instalment amount can be withdrawn.