ULIP v/s Term Insurance

Q. I have a ULIP policy but I have been advised that buying term insurance is better than buying a ULIP and I have been told that it is better to buy term insurance and mutual fund separately rather than combining it in a ULIP. Is this view correct? Please advise me on this and explain to me the rationale behind this view. Should I continue with my ULIP policy which I had bought about four years back or should I surrender it  and invest the same amount in term insurance and mutual funds as advised?

- Dilip Rane, Thane

A. Yes, Dilip, that is what I think too. Generally for the amount of life insurance that one needs, it is cheapest to buy it as a term cover. One has to arrive at the sum of cover needed after evaluating your savings goals, liabilities and existing savings. Buying life insurance covers for large sums can be very expensive and sometimes not affordable when one wants to buy ULIPs, endowments or money back policies.

The upfront costs in buying a ULIP are generally very high, going up to 35% of your first year’s premium! Since you end up with a reduced sum to start with, the compounding is obviously lower on your savings. The fee charged by a mutual fund remains lower and constant through the investment period at between 1.0% to 2.3% pa, whereas the costs in a ULIP reduce over time. If one intends to remain invested for more than 15 years, it remains acceptable to be in a ULIP. But, the cost of terminating a ULIP is high, reducing your flexibility to change the fund manager, if you so desire. In a mutual fund you are free to shift to another mutual fund if you are not satisfied with the performance. My opinion is that separating the two issues of protection and savings should be separated to give maximum flexibility and lower costs. If you are out of the exit penalty period, you could consider the step.[PAGE BREAK]

Q. I’m 25-year-old working with a state government undertaking in Mumbai. I keep hearing quite a lot about financial planning, but I am not able to understand the concept or how I should do the same for myself. Can you please explain to me what financial planning is all about in simple terms as I am not very familiar with financial jargon.

- Atul Sathe, Mumbai

A. Financial planning, in simple terms is a road map to your personal goals, quantified. All of us have goals to do with our own financial freedom, building up assets (homes), giving a better life to our families, education to our children, early retirement, social service, etc. All of them require careful planning as to when we want these events to happen and how much are they likely to cost. Once we are aware of this, we can start working backwards to see how much savings are required to achieve these goals; what rate of return is required to grow our savings and how do we achieve this required rate of return on our savings. This exercise, at the end, also makes us aware of how much we should control our spending so that we may generate the required savings.

Inflation of cost of living has a major to play in the process of determining cost – not present cost, but future cost. This higher future cost becomes our target for saving. Longer the time to goal, more the impact of inflation- hence it requires careful consideration.

The higher our ability to save, the lower will be the required rate of return on our savings. Conversely, lower our ability to save for the goal, higher will be the required rate of return on our savings. Either one tinkers around with the required rate of return or one has to reduce the size of the end goal! This is important, as one can imagine, higher the desired rate of return, higher is the risk to be taken. This is a personal call, best taken with the help of a financial planner.

There is a large range of savings instruments available to the retail investor today. Each has different risk characteristics. But largely, they can be classified as bond, equity and real estate. Within these asset classes, as they are called, you will have to plan your savings. The proportion of your savings into each of these assets is dependant on your need for liquidity, required rate of return, risk appetite etc. This in a nutshell, is what financial planning is all about!