How can one compare unit-linked plans of insurance companies, which are aggressively promoted as investment products with investments made directly in mutual fund schemes?
Both these instruments are designed to serve different purposes and are not comparable. A unit-linked plan from an insurance company is an insurance policy designed to pay a lump sum on maturity or on death if earlier. Premium paid under these plans is eligible for tax deduction under Section 88 of the Income Tax Act. On the other hand, mutual funds are investment avenues to participate in the growth of financial markets and do not provide any tax deduction (except ELSS and pension funds).
For a unit-linked insurance plan, providing life cover is the most important function; returns are just an added benefit, which gets magnified, given the tax rebates. Though unit-linked plans offer transparency in returns in terms of net asset value and flexibility in investment options in debt, equity or a mix of both, these advantages remain secondary. Whereas for a mutual fund, the main objective is to provide returns.
Moreover, unit-linked plans are not as liquid as mutual funds. There is a lock-in of three years. Even if one redeems after three years, you would be at a loss because of higher initial administrative charges. For example, the upfront charges for the first two premium amounts are as high as 20-27 per cent. Then there is an annual management fee of 0.8-1.25 per cent and a flat fee of Rs 15-20 per month. Finally, there is a deduction for risk cover. This goes towards contribution to the sum assured or the life insurance cover, which is based on mortality rates as calculated by actuaries. Though mutual funds too have entry and exit loads (maximum 2 per cent) and expenses (maximum 2.5 per cent), these costs are lower than unit-linked plans.
From your perspective, consider unit-linked plans only if you want insurance cover and not as an investment avenue to participate in the equity or debt market. If you want an exposure to the stock or bond market, mutual funds are better investment avenues. Don't go by the performance of these unit-linked products. Both unit-linked plans and mutual funds invest in the same financial markets. If the equity market is doing well, both equity-linked insurance plans and equity mutual funds will do well. But as an investment tool, you would be better off investing in mutual funds rather than unit-linked plans due to high fees charged by insurance companies. However, one has to forego that for the life cover that they offer. Thus, by design, unit-linked plans and mutual funds are not comparable and are meant to suit different objectives.