Mr Rahul was planning on seeking life insurance coverage but did not want to not miss out on a money-making opportunity from this investment. That’s when he came across a Unit Linked Insurance Plan or ULIP that offers insurance and investment in one policy. This way he could get the necessary financial coverage for his dependents, and still earn some returns on the investment. He was, however, concerned about the investment being made only in equity markets. Since equity markets are highly volatile, he did not want to assume a higher risk for his investment component of the ULIP.
After enquiring around with his peers who had invested in ULIPs, he got to know that equities aren’t the only place where this investment is made. It can also be made in debt securities and even a mix of both. If you are like Mr Rahul, wanting to know more on this, continue reading ahead.
The very nature of ULIPs make them insurance-cum-investment products. Thus, based on the risk appetite of each investor, a part of their premium needs to be deployed in risky or safe investments. For that reason, equity markets aren’t the only place where ULIPs invest. Debt funds are another area where ULIP investments are made.
Understanding debt and equity funds
Debt funds are investments made in debt securities(bonds and treasury bills). These instruments can either be short-term, medium-term, or even long-term. The instrumentscan also include specialised products, money-market instruments, and floating rate debt managed by professional fund managers. While debt instruments have a higher rate of return as compared to fixed deposits, they offer lower returns when compared to equity funds.
Equity fundsinvest in equity shares or stocks of different companies. According to the company size, geography, and investment style, these funds may be further classified into subtypes. Debt funds are suited for investors who are risk-averse, while equity funds are best suited for those investors who can assume a higher risk for consequent higher rewards. Thus, to reduce the risk that debt funds otherwise have, investments are even made in government and corporate bonds. On the contrary, equity funds are sensitive to market factors like inflation, tax rate, fluctuations in the currency, and policies of the central bank.
Based on the risk-taking capability of an investor, either a debt fund or equity fund can be selected. ULIPs, however, invest in both equity and debt instruments. Depending on the policyholder’s risk appetite, one can select which fund to invest in. Since ULIPs offer a mixture of insurance and investment in one single product, the policyholder can choose between the different fund types. Investment in equity funds can prove risky, as the fluctuations are directly linked to financial markets, whereas debt funds are comparatively less volatile. Another advantage of choosing either debt or equity funds, can be the achievement of the specific wealth creation goals of the policyholder. The mandatory five-year lock-in period ensures financial discipline and also the provision of sufficient time to accumulate substantial wealth, despite fluctuations of the market.
Fund switching between equity and debt funds in ULIP
Unlike traditional life insurance policies, where the investments made aren’t transparent to the policyholder, a ULIP provides transparency in terms of the investment that are made from its premiums. Besides that, fund switching is another feature that enables policyholders to modify their investment during the investment tenure to ensure that any amendment of their financial goal can be appropriately changed. For instance, an investor can easily make the switch from an equity fund to debt fund depending on their risk appetite. Financial experts advise to leverage higher risk instruments such as equity funds during the initial policy tenure, and then switch to debt funds towards the end of the policy tenure. This way, higher rewards earned during the initial years of policy can be maintained to offer a certain level of guaranteed returns.
To determine which funds to choose based on the magnitude of the risk, policyholders can make use of a ULIP calculator. It is a free tool offered by most insurance companies that helps the policyholders estimate the future value of the investment and also compare other ULIP policies. So, do not forget to make use of a ULIP calculator each time when switching funds to ensure that your financial goals are met.