In the previous column, we reviewed a case where a ULIP might have been a more appropriate product given the temperament of the investor. Compulsive spenders are another category who could benefit from investing in a ULIP rather than a more liquid product that they can easily redeem and squander the proceeds.
A more recent case I remember is that of a young couple, both well employed in the IT sector and earning handsomely, but somehow perpetually facing a liquidity crunch whenever a payment commitment became due. This forced them to keep redeeming their mutual fund investments at frequent intervals, thus robbing their portfolio of the crucial compounding element that boosts returns.
Clearly, their problem was not one on the supply side as they earned well and their cash inflows were pretty impressive. Their problem area was their inability to control cash outflows, especially avoidable capital commitments like costly club memberships that they never ended up using more than a couple of times. However, their opting for not just such a capital commitment but also ‘easy’ EMI installments to pay it further compounded their problems as the interest rates levied on them were abnormally high.
Ever since they shifted to a ULIP a few years ago, there has been at least some cap on their expenses as it is not quite as readily redeemable as a mutual fund. In such cases, the limited liquidity for the first few years actually works as an advantage for compulsive spenders.
A unique feature of a ULIP is the flexibility it offers an investor to switch between equity and debt, depending on market conditions without incurring any tax liability on the switch in and switch out. With a well-qualified advisor whose asset allocation skills are superior, this product can be used optimally to enhance returns or protection, depending on the objective.
Alongside, a ULIP also offers a Life Cover benefit which can be flexed if one wishes, on reaching different life-cycle stage milestones. Another deal sweetener is that ULIP premiums are eligible for a tax deduction under Section 80C for those still using the old Income Tax scheme. Furthermore, the returns received on maturity are exempt from income tax under Section 10(10D) of the Income-tax Act provided the premium paid per subscriber in a family was Rs 2,50,000.
In the case of a ULIP too, the objective should be to stay invested over a long-time horizon and not the minimum mandatory 5-year lock-in period. With the right allocation mix based on a long-term goal or objective, the returns over a 10-to-12-year period can quite often be better than anticipated.
Having observed investor behaviour at close quarters, I have noticed that ULIPs usually inculcate a forced sense of discipline into those investors who are best suited for this product. More importantly, it ensures that they do not barter their long-term goals and objectives to fulfill their near-term needs and desires. And that to my mind, is the deal clincher for such investors.
(Ashok Kumar heads LKW India. The views expressed here are his own)