A diversified portfolio helps investors to build wealth while minimising the risk. Mutual Funds and ULIPs (Unit Linked Insurance Plans) have become essential part portfolios of many investors as they both offer higher return.  Choosing the investment options depends on the investor’s goal, risk appetite and financial needs. If you are looking for building wealth over a period of time then both mutual funds and ULIPs could be your options.

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However, both these investment products come with higher risk as they are market-linked. Though both mutual funds and ULIPs have many similarities but they are separate products with their distinct advantages and limitations.

What is a mutual fund?

One of the most popular investment options in the present time, a mutual fund is a financial instrument where funds are pooled collectively from individuals and institutional investors for further investment. An asset management company (AMC) or mutual fund manager invests these funds in equity, debt and money market instruments. These funds are managed by fund managers who make investment decisions on behalf of the investors. After the deduction of expenses and charges, the profits are distributed among investors. Notably, this amount is determined by the Net Asset Value (NAV).

What is a unit linked insurance plan?

Unit-Linked Insurance Plans (ULIPs) are insurance policies that offer insurance coverage along with returns based on investments made in market-linked avenues. The major difference between ULIPs and mutual funds is the insurance component. While ULIPs provide insurance with savings, mutual funds don’t offer insurance protection. Funds in ULIPs are invested in equity shares, debt instruments, and bonds. Many ULIPs also come with some unique benefits like partial withdrawal, tax benefits, and a choice of life cover.

Which one is better between ULIPs and Mutual Funds?

Financial goal and objective:  While mutual funds are particularly focused on wealth creation, ULIPs are focused on both wealth creation and insurance coverage. So, if you want to build wealth mutual fund could be a better choice. On the other hand, if you prefer investing in a market-linked insurance product then go for ULIPs.  

Investment horizon: Mutual funds come with short-term, medium-term and long-term investment options. In a few mutual funds you can even invest for a period of one year. ULIPs are usually long-term plans with a lock-in period of at least five years.

Tax benefits: All mutual fund investments are not tax exempt. Only investments in Equity-Linked Savings Scheme (ELSS) qualify for tax deductions under Section 80C of Income Tax Act, 1961. In the case of ULIPs, tax benefits can be claimed under Section 80C for premiums paid. The maturity amount is also eligible for tax deduction under Section 10 (10D).  

Premium payment: Investors can choose a systematic investment plan (SIP) for mutual funds or invest a lump sum amount. On the other hand, most of the ULIP come with regular premium payment options.

Mutual funds are an ideal option for those looking for a short-term or a medium-term investment plan along with high liquidity and can tolerate high or medium risk. On the other hand, ULIPs are good for those who want long-term options along with an insurance cover and comparatively  lower risk.