Mutual fund, is a purely market linked instrument, which pools the money of different investors and invests them in different financial securities like stocks, bonds, money market instruments and Government Securities etc. Each investor in a mutual fund owns units of the fund proportionate to his investments, which represents a portion of the total holdings of the mutual fund.
To know more please read What are Mutual Funds in India and What are the benefits of investing in Mutual Fund in India
On the other hand, Unit Linked Insurance Plans (ULIPs) are combined life insurance-cum-investment products. Unlike traditional insurance plans like, endowment policy, money back plans, pension plans and term insurance plans etc., ULIPs are market-linked products and have the potential to deliver higher returns compared to traditional life insurance plans. ULIPs invest in different market linked investments and offer basket of products like, equity funds, balanced funds and debt funds. The policy holder can choose a fund based on his/her risk appetite.
However, ULIPs, unlike traditional life insurance plans, do not offer capital safety as the investments are market linked.
ULIPs deduct expenses on account of fund management charges, mortality charges and policy management charges etc. The charges are deducted from the policy account by redeeming units. ULIPs declare daily NAVs based on the valuation of underlying securities in the portfolio.
Mutual funds, on the other hand, is a purely market linked instrument, which pools the money of different investors and invests them in different financial securities like stocks, bonds, Government Securities etc.
There is an expense ratio which is charged to the investor and its gets adjusted in the NAV. Mutual funds declare daily NAVs after adjusting the expense ratio and therefore, unlike ULIPs, no units are redeemed from the account of the investor.
There are different kind of mutual funds, like open ended funds and close ended funds. Though ELSS is also an open ended fund but it is locked-in for 3 years as it offers tax rebate. Open ended funds can be bought and sold anytime. However, in case of ULIPs, the policy holder has to pay minimum 3 annual premiums and it is locked-in for 5 years during which the policy holder cannot redeem the policy.
One can think of ULIP as a mutual fund with a term life insurance plan attached to it. In terms of gross investment returns ULIPs have performed comparably with mutual funds over a 5 year period.
However, net returns to investors are lower in ULIP because various costs are deducted from ULIP premiums before they are invested in the ULIP fund chosen by the policy holder. A portion of the ULIP premium goes towards buying the life cover or sum assured (it is called mortality charges). Another portion goes towards a variety of fees like, premium allocation fees, policy administration fees, fund management etc. The balance premium is then invested in the ULIP fund.
In our opinion, investors should not mix investments and insurance together. For wealth creation and other investments needs, investor should invest in mutual funds which offer investment solution for 1 day to entire life. One should consider life insurance for pure protection purpose and should not look for return from life insurance plans. For protecting life, term insurance plans are the best option.