You may have finally zeroed in on the ULIP that you want to buy. After all, your advisor has just told you that a ULIP is more tax-efficient compared to a mutual fund because long term gains on ULIPs will not be taxed at 10%. You are however still not sure if investing in ULIP is good or bad. How do you make that choice? Here is a ULIP investment guide that looks at ULIP investing from the perspective of the common mistakes to avoid when buying life insurance and ULIPs..
1. Choosing the wrong plan
A ULIP typically offers you a choice of plans. You can select the plan according to your return requirement and your risk appetite. If you are looking for a higher yield and are willing to take on higher risk then you can look at equity focused plans. Else you can either look at pure debt plans or predominantly debt plans. Many people commit the mistake of choosing the wrong plan and in fact do not even realize the same. Consult your financial advisor and also check if the plan is suited to your risk appetite and your return requirement.
2. Treating ULIP as a 5-year investment
As you must be aware, ULIPs come with a 5-year lock-in. However, that does not mean that you must exit your ULIP immediately on the completion of 5 years. This is not a medium term investment product that you are talking about. The 5-year lock-in is just for your comfort and liquidity in the case of an emergency. When you are invested predominantly in equity funds then you must let the ULIP run its full tenure. Remember, ULIP is designed to be part of your long term financial plan. When you redeem the ULIP in 5 years you are actually disrupting your long term plan.
3. Not understanding the purpose of the ULIP
Be clear why you are buying the ULIP. If you are looking at just an insurance cover then a term policy will serve you well. On the other hand, if you are looking for an appreciating investment then an equity fund will be a better choice. A ULIP should be chosen when you seek the benefits of combining your insurance and your investment under one head for the sake of convenience. Also, the combination must give you distinct advantages over combining the two products in terms of convenience, tax breaks etc.
4. Not focusing on the costs entailed
Costs matter a lot in ULIPs because it makes a big difference to your net return and even to your payback period. A ULIP under bullish market conditions will take nearly 7-8 years to break even and that will be your payback period without considering the time value of money. There are visible and invisible loads on your ULIP policy and therefore you need to read the fine print to familiarize yourself with all the loads. You can also check with your advisor about your interpretation of costs involved.
5. Opting for the single premium plan
Most ULIPs offer you choices of opting for a single premium plan or for a regular investment plan. Your regularly investment can be annual, half yearly or quarterly. You can choose your timing based on your cash flows. A single premium does not give you the benefit of rupee cost averaging especially if you are investing at higher levels of the market. Also, regular payment plan helps you spread your tax benefits across more number of years. Single premium policies are best avoided unless you are opting for a pure debt plan.
6. Not understanding switching flexibility in ULIPs
This is a common mistake that many investors commit. Assume that you have committed to a debt plan, it does not mean that you cannot change your decision. In fact, ULIPs permit you to switch from one plan to another without any tax implications. That does not mean that you have to be fickle minded about your choice. In case you have opted for a particular plan and find that it does not fit into your risk appetite, then you can change it. It is as simple as that! The choice is always available to you.
7. Believing ULIPs to be a guaranteed investment..
Assured returns schemes died with US-64 in 1998. That was an important lesson for all stock market investors that guaranteed investing was dead. If your ULIP is invested in the equity markets then it runs the risk of equity investing like in case of any other equity mutual fund. Be clear at the outset that ULIPs are an investment that entail risk. Of course, equities do tend to outperform other asset classes over longer period of time. That still does not mean that your ULIP is guaranteed to give you positive returns!