Mutual Funds v/s ULIPs: What should investors invest in?

The recent happenings in the investment industry, expecially the recent ULIP related issues between SEBI and IRDA have raised quite a bells. Recently, the SEBI chariman, Mr. Bhave, was reported to have launched a scathing attack on Mutual Fund Houses (as quoted by ET), and was critical of the way the funds do business. Another development that happened was ULIP's were given a clear dictate - ULIP's are to be controlled by IRDA, not by SEBI. That has led to lot of worries for Mutual Funds, especially because sometimes back the Mutual Funds Entry load was scrapped by the regulators. That resulted in a big loss of income for these mutual fund houses. (See our thoughts on Should you trust your mutual fund manager?)

Mutual Funds v/s ULIPs: Which is better & What should investors select to invest?

In all these developments, one thing has come out clearly. There are lots of confusing financial products in the market and the investors interest are least thought about. Various AMC, Fund houses, Insurance Companies and other investment firms, come out with their own specially customised financial products, which may or may not ever meet the customer needs. They are sold through agents, who are guaranteed a hefty commission on each sale, and hence a lot of mis-selling happens. Simple because the agents are more interested in "Earning More Commission" rather than selling something which will actually benefit the customers or investors. More importantly, do such products exists which really are serving the purpose of investment like education policy, health plan, insurance plan and so on??? Please see this example Insurance v/s Investment v/s Tax savings – agent based business, where a good example is cited about how investors might fall prey to mis-selling and end up buying something which is not in investors benefit, but agents benefit.

Take a simple example - there is a good financial product which suits the purpose of your investment and it gives a 5% commission to the agent. Then there is another financial product which does not suit your investment purpose but gives 40% commission to the agent.
Now put yourself in agent's place - which policy will you sell - one that gives you 5% or one which gives you 40%?
You trust your agent thinking that he/she knows finance better and you go by his advice. But there is a good enough chance that the agent will sell you something which is not in your favour, but in his favour as a hefty commission.

The recent decision that ULIP's will be controlled by IRDA and not SEBI has sent cold waves across mutual fund houses. The reason - SEBI controls Mutual Funds, and it has (Rightly) barred them from charging any entry load or commission. So investors money is actually invested in full. The agent's commission and entry load are things of past.
However, for ULIP or Unit Linked Insurance Plans, they are controlled by IRDA, where there is no such restriction. It still remains a pure commission & agent based business. Some ULIP offer as high as 60% of first year annual commissions to agents. The industry avaerage is around 40%.

Now think about it. What will an agent sell? Something which will not give him any commission (Mutual Funds) or something which will give him hefty commisions (ULIPs)? Obsiously the answer is ULIP's. They come with loads and loads of conditions and strings attached. Investors need to remain invested for a long period like 15-20 years. Early exits (even like 5 years or so), might see even the invested money not being repaid in full.

So this is where we stand. The Mutual Fund Industry is worried that since agents are not allowed any commissions on selling Mutual Funds, the Mutual Funds will take a hit. On the other hand, the ULIP's will be (mis)sold with high recommendations by the agents, as they are going to give them high commissions. Another point is the word "Insurance". ULIPs stand for Unit Linked Insurance Plan - it has some component of money that goes towards insurance premium. However, the insurance cover provided is usually not sufficient and it ends up being a mix of insurance plus investments, with none of the two purposes achieved.

At this point, Investors should think twice before selecting an investment product. In my opinion, what SEBI is doing is correct - they are looking for investor benefits. ULIP's still require a lot of changes to really become a transparent and beneficial product to customers.