An increasing number of investors are including unit-linked insurance plans, more commonly known as ULIPs, in their investment portfolios. Unit Linked Insurance Plans provide life coverage along with an option to earn returns through investing.
A portion of the insurance premium is used towards providing life coverage. The balance is invested in different funds of your choice. You may choose to invest this portion of the premium in equity, debt, or balanced funds.
Different insurance companies offer various types of ULIPs. However, because there is an investment option included in the ULIP investment, there is a certain inherent risk. Therefore, you must understand the risks involved in a ULIP plan before investing in one.
Understanding the Risks
This term primarily means the variability related to investing in different financial products. It is also the increase or decrease in the return on investment when compared to your expectations.
If this difference is large, it means the investment entails higher risk and vice versa. Every person has a different risk appetite. Your risk-taking appetite depends on factors such as your age, financial goals, investible capital, and investment horizon.
Moreover, if an investment is capable of delivering higher returns, the risks associated with investing in it are also greater.
5 Factors Before Investing in ULIPs
ULIPs provide some life coverage. Nonetheless, a portion of the premium is invested in financial instruments. Therefore, there are certain inherent risks when you invest in ULIPs. Here are five such risks associated with ULIPs.
1. Market Risks
The returns on the ULIP are directly related to the increase and decrease of the capital markets. The Net Asset Value (NAV) of the fund is affected not only by the volatility of the equity markets but also by the increase or decrease in the interest rates. Therefore, even if you choose to invest in debt funds, there is some risk in case the interest rates decline, which in turn reduces your return on investment.
2. Risk of Returns
Investments like fixed deposits offer guaranteed returns when you stay invested for the entire duration. However, the returns on the ULIPs are not assured because these are directly affected by the changes in the financial instruments. Therefore, as an investor, you must bear the portfolio risk when you invest in ULIPs. The expertise of the fund manager and the performance of the underlying asset determine the NAV of your funds and affect the returns.
3. Liquidity Risks
ULIPs come with a minimum lock-in period of five years. However, most ULIPs have an investment horizon of ten to 15 years and it is recommended that to maximize your returns, you stay invested for this entire tenure. Therefore, compared to other financial products, ULIPs are less liquid. This means that you cannot exit your investment before the lock-in period irrespective of why you need emergency funds.
4. Performance Risks
A smart investor always does his research to not only understand ULIP’s meaning but to also compare different product offerings. You may also take the time to research the performance of various plans offered by the different insurance companies. However, if a fund has performed well in the past, it does not necessarily mean that the same performance will be in the future. It is almost impossible to determine the future performance because the investment markets are volatile and predicting their movement is nearly an impossible task.
5. Higher Costs
ULIPs involve several charges such as premium allocation, policy administration, fund management, mortality, and surrender or discontinuation charges. These may vary from one plan to another. However, when all these various charges are included, the total costs of investing in ULIPs are significantly higher when compared to most other financial instruments. These charges are deducted from your investments, which reduces the effective returns on your investment.
Although there are several risks associated with ULIPs, these are a good option to include in your investment portfolio.
Things to Consider Before Investing in ULIP
Here are two things you must consider before making an investment decision:
1. Understand Your Risk Profile
You must understand how much risk you are willing to assume before you invest in ULIPs or any other financial instrument. Your risk appetite often depends on factors such as your liquidity position, personal requirements, and investment tenure. You must clearly understand investing in ULIPs and the possible returns or outcomes through such an investment. An online ULIP calculator will help you understand more about investing in such plans. Knowing the various factors before making an investment decision is important to ensure you are not surprised in the future.
2. Remain Invested in the Long-Term
As already mentioned, the lock-in period for ULIPs is five years. However, ULIPs come with an investment horizon of ten to 15 years. When you remain invested for the entire duration, you can reduce the risk of market volatility.
Therefore, there is a higher possibility of earning greater returns. Moreover, the ULIP charges are often higher in the initial years, which impacts your actual returns. Over the years, these charges decrease and a larger portion of the premium is invested in market instruments. This provides you with the opportunity to earn higher returns over the long term.
Different insurance companies offer various types of ULIPs. Therefore, you will be able to find a plan that most appropriately suits your personal needs and risk appetite. It is recommended you spend some time researching different options to make an informed decision.
