Why should you opt for a term plan- MF combo?
A term plan-mutual fund combination is the most efficient financial plan out there. On the other hand, a ULIP levies several charges other than the fund management charge (that mutual funds also charge) and mortality charges (that term plans also charge). Additionally, they levy premium allocation charges, administrative charges, and so on also.
At the same time, the cost structure for a ULIP is also quite complicated. Charges that are levied under endowment plans and money-back policies are unknown, while charges under linked policies are very clearly mentioned in all policy brochures as well as policy documents that are available on the company website. The only problem is that investors are either unaware or are not interested in taking the pain to go through the policy details before finally making a purchase. Insurance companies, advisors, and agents all take advantage of this ignorance and sell policies that are not even helpful for the consumer. This is where the mutual fund – term plan combination wins, by having a much lower and transparent cost structure.
Yet another problem with a UIP is that the insurance company offers only limited fund options. Thus, if the funds that are offered by the insurance company underperform, the investor does not have the option to exit the current fund and invest in another high return fund from another company, until the lock-in period ends. On the other hand, had the investor invested in a mutual fund, he can easily exit the current underperforming fund and choose to invest in any of the variety of funds that are available out there.
Endowment plans, moneyback plans, and other traditional products have many other drawbacks too; the biggest one being that they offer simple interest. For that matter, mutual funds and even the Public Provident Fund offers the power of compounding to grow your investments. The effect of compounding is very powerful, especially over the long term.
Another disadvantage of traditional products is that they have a high allocation to debt products, which affects their returns over the long term since returns from equities always trounce those from debt.
Another drawback of insurance-cum-investment products is that despite paying a hefty amount as premium, a family could still be under-insured. On the other hand, term plans are not very expensive, so you can easily buy an adequate amount of coverage through them.
What can investors do?
Exit and bear the losses
If an investor has invested in a ULIP or traditional products, and if the premium has been paid for only two or three years, the best solution here is to exit these policies right away. Older ULIPs had a lock-in period of three years, which has now been extended to five years in the new ULIP. Thus, if an investor does exit from an old ULIP after paying two premiums, he or she would lose out on the premium completely. However, if he exits after three years, all that he would probably get would be the third year premium; since the rest would be eaten by the charges associated with ULIPs. For a longer-term period, of, let us say 20-25 years, it makes a lot of sense to exit these policies, even if you lose out on the premium. Move on to mutual funds and term insurance instead.
Not all investors are financially savvy. Some have little knowledge of the term plans since agents do not push them. They also have limited information about mutual funds, since there still is greater awareness about insurance products over mutual funds in small towns. These kinds of investors are wary of such options.
These investors would prefer a ULIP to a mutual fund-term plan combination, since a ULIP, being a product that is offered from an insurance company, seems to offer a greater sense of security. Naturally, these investors would stay put in the ULIP. Even though it is not a financially efficient product, it will still benefit these investors, by offering them equity exposure. And this would boost their returns in the long term.
Choose the middle path
Some investors are financially savvy and understand the logic behind exiting a ULIP or other traditional products. At the same time, they shy away from writing off their premium in the ULIP entirely. Very often, the premium that they have paid is as high as INR 1 lakh or more per year. Thus, bearing the losses upfront can be difficult.
For investors like these, the middle path of making the policy ‘paid-up’ is the best option. Enquire from the company about the minimum period for which you need to pay premiums, pay till then and then stop. Thereafter, the policy will continue to exist. The insurance company will deduct the annual charges from the wealth that has been accumulated and then keep the policy alive. The paid-up policy will offer a lower sum than what was assured, but the investor would be saved. The benefit of opting for this method is as follows. The investor would feel that he or she has not lost the entire money; though if you do the math, the first option is the most optimal one.
It is apparent that once you enter these high-cost insurance-cum-investment policies, there is no way out for a painless exit. If you have not been in these policies for long, taking your losses upfront is the best course of action to get your financial portfolio back on track.