What are Absolute Returns in ULIPs?
Unit Linked Insurance Plans combine the benefits of two finance products, insurance and market-linked investments. While insurance offers a security cover from unforeseen future circumstances, the investments allow wealth creation to the individuals. There are many ULIPs in the market today. Hence, the main question that arises is which ULIP investment will yield the best returns based on your risk appetite? Let’s examine the various factors that influence ULIP performance.
ULIPs: How to Choose?
Investors should carefully research and evaluate their investment goals before selecting a ULIP. Apart from that, below are some factors one should evaluate when selecting a ULIP:
- Different costs
- As with most financial products, ULIPs come with various costs. The charges include allocation charges, fund management charges, surrender charges, administrative charges, and mortality charges, among others. An investor gets the returns after the deduction of these ULIP charges. Hence, it is essential to consider all these costs carefully before committing to one.
- Additional benefits
- Many ULIP plans offer investors additional benefits, such as:
- Issue of loyalty bonus units
- Flexible premium payment options
- Unlimited switching options between different ULIP plans with no or minimal cost.
- Calculation of returns
- Today, investors can calculate the approximate returns they will receive from ULIP investment through online ULIP calculators. These calculators only require investors to enter the investment amount and the period of investment and will calculate the approximate return. Hence, it makes it easier for investors to compare different ULIP returns from the comfort of their homes.
- Investors can use the following formulas to calculate returns on a ULIP policy:
Compound Annual Growth Rate (CAGR)
It involves calculating the mean annual growth rate of ULIP over a length of time, usually more than one year. However, it does not account for the volatility of returns. Also, it is not a viable method if the investment period is less than one year. It is for this reason that the second method is popular. The formula to calculate the CAGR is as follows:
CAGR= [ (Current NAV/ Initial NAV) * (1/number of years)]-1
This is a more preferred way of calculating returns on ULIP. Before we discuss how to calculate the same in ULIPs, let’s understand some of the features of absolute returns.
Why are Absolute Returns More Popular Than CAGR?
As the name suggests, absolute returns represent the absolute profit or loss that investment has seen over a specified period. Here are the reasons for its popularity among fund managers:
- Portfolio diversification
- Absolute returns aim to ensure positive returns regardless of market conditions. As a result, the funds are diversified to gain profits and reduce risks so that positive returns can be achieved.
- Minimum volatility
- The additional benefit of diversifying your portfolio is that the overall returns will be less volatile. Since the portfolio’s risk is spread across several assets, market volatility has a lesser effect on the portfolio.
- Independent tool
- The absolute return is calculated without regard to market benchmarks or indexes. Here, the returns on investments are not compared with market returns earned by similar investments. Alternatively, we can say it is not a relative return.
What Do We Mean by Absolute Returns in ULIP?
- The absolute return can be defined as the total return a plan gives over a certain period. In some cases, the duration can even be less than one year. This metric measures the net profit or loss of investment. It is also known as the net asset value of an investment.
- A net asset value is calculated by finding the difference between the current value of an investment and its initial value, and diving the amount by its initial value. ULIP costs will also be deducted from this value to arrive at the final return value.
- Now, depending on market conditions, an investment can either appreciate or depreciate. Therefore, absolute returns can either be positive or negative. In addition, it is expressed in percentage form.
- In light of the above information, the formula for absolute returns is:
Absolute return = (Current investment value – Initial investment value)/Initial investment value)*100
- Let’s explain this further with an example.
If, for example, the original investment value was Rs 50,000 and the current value is Rs 150,000. Applying the formula, the absolute return of the investment will be:
(150,000-100,000)/ 100,000)*100 = 50%
- With absolute returns, an investor can obtain insight into how his/her investment has performed. However, this method will not show how quickly a particular investment grew or declined. In such cases, the CAGR method can be used to calculate an investment’s average growth. Additionally, it is a better method if you want to compare two investments.
- A ULIP investor can maximise the return on their investment by:
- Defining the financial goals
- Understanding the risk appetite
- Managing the asset allocations
- Maintaining patience and discipline
By now, you may have a fair idea of what absolute returns are and how to calculate them when investing in ULIPs. Also worth noting is that there have been some changes in the income tax rules related to ULIP investments. Tax exemptions previously granted to ULIP investors on the maturity amount will no longer apply if the premium payable exceeds Rs 2.5 lakh.
Furthermore, any profit realised from such an investment will be taxed like equity products. You can always seek clarification from a financial advisor if you have any doubts on this matter.