What are Absolute Returns in ULIP Plans?
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Updated date : 03 January 2020
ULIPs are a great option of investment in a long-run. However, in recent times, only a handful of them have reduced the charges they levy. The new generation ULIPs has been found to be a consistent performer in a long-term investment strategy. So, many investors are considering investing in them.
What is an Absolute Return?
Absolute returns are nothing but those returns that the assets tend to achieve over a certain, specified period. This is expressed as a measure of the appreciation or depreciation of the assets. These assets could either be stocks or mutual funds. In simple terms, absolute return or the total return is the profit or loss made by the portfolio in a given time frame. It is not dependent on any benchmark, may be positive or negative and have absolutely no correlation whatsoever to the position or activities of the market.
What are ULIP Plans?
ULIP, also known as Unit Linked Insurance Plan is another type of investment product which is a combination of both an insurance policy and an investment plan. The basic goal here is to invest a part of the premium in bonds or shares and keep the rest for offering insurance cover. The main advantage of these plans is that they allow the investor to make a switch between equity and debt investments, all of which depends on your risk-taking capabilities and what you know about the performance of the markets.
The norm for the lock-in period of ULIPs was set at three to five years. However, since ULIPs also come with insurance, you may not be able to get the benefits of the plans unless you hold it for the entire 10 or 15 years.
Benefits of ULIPs
One of the major benefits of ULIPs is that it offers life coverage along with the benefits of investment. What's more? It even provides financial security to the family of the taxpayer, in case of his or her sudden, untimely demise.
Besides this, another important benefit of ULIP which most people tend to ignore is that it can save you on taxes. The premiums paid towards ULIPs are eligible for a tax deduction under Section 80C. Also, the returns you gain from these plans are exempted from taxes as per Section 10D. So, the benefits you get by investing in these plans are twice as much.
Another advantage of investing in ULIP plans is that it helps you achieve any long-term financial goal. This is because, the money you put into these schemes are compounded, and hence, the returns are usually tend to be higher. Thus, as compared to other investment option like FD, the ULIP plans offer higher returns. However, you need to stay invested for longer periods if you want good returns.
ULIP plans also offer the flexibility to switch between debt and equity investments. According to your risk appetite and knowledge of the market trends you can make free switches between funds.
ULIP Plans and Absolute Returns
There are two basic types of returns generated by ULIPs. The first one is called absolute return and the second one is called compounded annual growth rate. Many insurance firms levy a certain amount of charges, which is to be considered when calculating the different types of returns generated by ULIPs. These can be anything, ranging from surrender charges, fund management fees, mortality charges, premium allocation charges, administrative charges, and so on.
Having said this, let's see now what absolute returns in the pretext of ULIPs are.
Absolute returns are determined by the current and initial NAVs (Net Asset Values) of the ULIP. These are expressed as a percentage of the initial NAVs. This can be considered as one of the most effective ways of determining the ULIP's performance when invested for a shorter duration. For instance, if your initial NAV was Rs. 100, and increased to Rs. 150, then this means that the absolute return for the said ULIP is 50 per cent.
However, even if this method is very efficient, it has its own disadvantages as well. For instance, you may use this method to calculate your returns at any point of time during the investment. However, it is more beneficial if you could determine your returns only during the initial years.
In any case, this formula only helps you determine your returns based on the capital investment. It's of no use if this investment is compounded.
ULIPs and Mutual Funds
Although ULIPs also offers the benefit of insurance coverage, it provides higher exposure to market risks to the investors, because their portfolios are linked to it. But ULIPs have been a great success, ever since their introduction into the investment scenario, and have given good returns, nonetheless.
Mutual funds, on the other hand, are pure investment products in which the money is majorly invested in different market instruments like equity, debt, stocks, money market fund, etc. in order to gain maximum return on investment and create corpus over a long-term period. Mutual funds are classified into different categories based on their risk exposure. Some factors that affect these investments include the risk exposure, the potential of returns, the lock-in period, the liquidity of the funds and more.
What Risk Exposures They Have?
ULIPs tend to have lesser risk as compared to the mutual funds, as they are also insurance products. However, ULIP investment includes a considerable amount of risk since they invest in equities and bonds alike. On the other hand mutual funds tend to pose a greater risk than ULIPs as the investment is majorly made in equities followed by hybrid and debt funds
What Returns do they Give?
ULIPs are low-risk products. Thus, their returns also tend to be lower. On the other hand in mutual funds investment it's always the equity-oriented funds that give out higher returns and not the hybrid funds or the debt funds. However, hybrid funds do offer better returns than their debt counterparts.
What is the Lock-in Period for Each?
ULIP plans offers a minimum lock-in period of 3-5 years. However, mutual funds don't come with any lock-in periods, which mean that you can buy or sell them at any point in time.
As far as mutual funds are concerned, these However, there are specific mutual funds such as closed funds which do come with their lock-in periods going up to three years.
Which of the Two is More Liquid?
Liquidity is that factor by which investors can redeem investments quite comfortably. It is also concerned with the amount of time taken to receive your redemption. Mutual funds come as more liquid than ULIPs since they are the most widely traded products in the stock market.
What Charges are Levied?
One of the most prominent advantages of mutual funds is that the charges levied are low, and they are professionally managed. The fee to manage these kinds of funds typically ranges from one per cent to two per cent. On the other hand, the charges levied for managing ULIPs are significantly higher.
So, as an investor, you will need to understand the major differences between the two investment products. Remember, the purpose of insurance is always to secure your family and their future and the purpose of the investment is to accumulate more wealth.
So, both ULIPs, and mutual funds come with their own set of risks and rewards. Understanding them thoroughly will help the investor go a long way in his or her investments.
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