Today, insurance companies provide different types of Unit-Linked Insurance Plans (ULIPs) to suit the various needs of investors. You may think that investing in a ULIP is a simple and quick procedure. However, with the numerous choices that are available, making the right decision is not that simple.
ULIPs have a unique feature that differentiates it from all other types of life insurance plans. These types of plans include insurance coverage as well as investment. The complexity of ULIPs often leads you to make some common mistakes while investing. Here are six mistakes you must avoid while investing in a ULIP.
- Availing of an incorrect plan
Before you make an investment decision, it is crucial you analyze your financial obligations, risk profile, and liquidity needs. Failing to do this may result in you investing in an incorrect ULIP plan. The money pooled in by different investors in the plan is invested in market instruments. If you make an incorrect investment decision, it may result in enhancing your risk because the ULIP returns are based on market performance. ULIPs invest not only in equities but also in several other debt and cash products.
If you do not adopt an appropriate asset allocation while investing, it may result in a huge mistake. Assume that you are a salaried person with a home loan, children’s school expenses, and other financial commitments. In this situation, investing in an aggressive equity-oriented fund may not be the right choice. It may be more prudent to invest in a balanced fund.
- Investing in the short-term
A ULIP investment comes with a minimum lock-in period of five years. Additionally, your investment is eligible for tax exemptions under section 80C of the Income Tax Act. It is common that you may exit your investment at the end of the lock-in period. However, this is not always a wise choice because you must remember that insurance is a long-term financial instrument. Moreover, ULIPs have several upfront charges, which is why the returns in the short term are not very high. To maximize your benefits and earn higher returns, it is recommended you remain invested for at least ten years or longer.
- Incorrect investment reason
It is seen that investments in ULIPs rise significantly during the tax season. This is because many investors opt for ULIPs only to reduce their tax liability. Although ULIPs are an excellent way to reduce taxes, your decision must not be solely based on this advantage. You need to make your investment decision as per your financial objectives and the other benefits associated with ULIPs. Therefore, you must analyze and evaluate your requirements and reasons before making your decision.
- Limitation in awareness
When you want to invest in the best ULIP plan, you must avoid making your decision without understanding the features in totality. You must learn and understand about the product features, terms and conditions, and fees and charges. Moreover, you must clearly comprehend about the versatility of ULIPs as related to free switching between funds and top-up features. Insurance companies allow you to switch from one plan to another without any implications on your tax liability. Therefore, if you invest in a particular plan and later want to modify it because you do not want to assume higher risks, free switching is beneficial. However, you need to know that only certain numbers of free switches are available and insurers charge a transaction cost for other subsequent switches.
These beneficial features will help you earn higher returns in the long-term. Therefore, it is important that you take the time to understand and procure awareness before making the investment.
- Least expensive is the best plan
It is a common perception that the least expensive plan is the best option. However, this is a huge mistake and must be avoided. Although reducing the cost is advisable, you must not make your decision based on this single factor. It is important that you evaluate past performance of the different plans to make an informed decision. You may easily compare the various ULIPs available in the market online. It is important that you invest as per your requirements. Take into consideration the exclusions and limitations of different plans before making any decision.
- Choosing a single premium plan
Most insurers offer regular premium or single premium ULIPs. The regular premium plan may be quarterly, half-yearly, or yearly and must be based on your cash flows. When you invest regularly, you are able to benefit from rupee cost averaging, which reduces your overall investment cost. When you opt for a single premium plan, this benefit is lost especially if you invest during market highs. Additionally, a regular premium plan allows you to spread the tax benefits over several years. A single premium plan must be avoided except if you opt for a pure debt fund.
A common misconception among ULIP investors is that such plans deliver guaranteed returns. However, the corpus is invested across different instruments. Therefore, if your money is invested in equities, the returns are based on the performance of the stock market. Therefore, you must remember before investing that like mutual funds, ULIPs are also affected by market movements. Nonetheless, equities have delivered superior returns compared to other investment products, especially in the long-term. Therefore, investing in ULIPs is a good option; albeit without expecting guaranteed returns on your investments.