Unit Linked Insurance Plans (ULIPs) and equity shares are two popular investment options offering the potential of wealth creation, life cover and ownership rights, respectively. However, both also come with certain risks that investors should be aware of before investing their money. In this blog, we will compare the risks involved in ULIPs and equity shares and see how they differ.
What are ULIPs and equity shares?
If you think about what is ULIP, then they are hybrid investments that combine insurance and investment in a single plan. A part of the premium paid for a ULIP policy provides life cover to the policyholder, while the rest is invested in various market-linked funds, such as equity, debt, or balanced funds. The policyholder can choose the fund option as per his/her risk appetite and financial goals. The returns from ULIPs depend on the performance of the chosen fund and the market conditions.
Equity shares, also known as common stock or ordinary shares, represent ownership in a company. When an investor buys equity shares, they become a company shareholder and have a stake in its success. In return for their investment, shareholders are entitled to receive a portion of the company’s profits, known as dividends, and voting rights in its decisions. The returns from equity shares depend on the company’s performance and the market demand and supply.
What are the risks involved in ULIPs and equity shares?
Both ULIPs and equity shares are vulnerable to market risks, so their value can fluctuate depending on the economic and political factors affecting the market. However, the degree and nature of risk vary for both products.
ULIPs have different types of funds with different risk and return levels. Equity funds are the most risky, as they invest in stocks of companies that are prone to market volatility. Debt funds are less risky, as they invest in fixed-income securities that offer stable returns.
Balanced funds mean a mixture of both, equity and debt funds; they offer a balance of risk and return. ULIPs lets the policyholder switch between funds per the changing market conditions, without any tax implications. This helps reduce the risk and optimise the returns.
Equity shares have a high risk-reward ratio, as they can offer high returns when the company and the market perform well but can also incur huge losses when the opposite happens. Equity shares are also subject to liquidity risk, meaning they may not be easily sold or bought at a fair price in the market. Equity shares also have no guarantee of returns or capital protection, unlike ULIPs that offer a minimum sum assured as life cover.
How to manage the risks involved in ULIPs and equity shares?
The risks involved in ULIPs and equity shares can be managed by following some prudent investment strategies, such as:
Diversify Your ULIP Portfolio:
- Spread your investments across various funds rather than concentrating on a single fund.
- Diversification helps mitigate the impact of underperformance in any specific sector.
Regularly Review and Rebalance:
- Keep a close eye on market conditions and periodically reassess your ULIP portfolio.
- Rebalance your investments as needed to align with your risk tolerance and market trends.
Understand and Monitor Charges:
- Be aware of charges associated with ULIPs, including fund management charges, policy administration charges and premium allocation charges.
- Understanding these fees is crucial to prevent them from eroding your overall returns.
Thorough Research for Equity Shares:
- Conduct comprehensive research on the financial health, growth prospects and competitive position of companies before investing in their shares.
- Stay educated about market trends, economic indicators and relevant news impacting your chosen stocks.
Diversify Your Equity Portfolio:
- Avoid concentration risk by diversifying your equity investments across different sectors.
- Spreading your investments helps minimise the impact of poor performance in any specific industry.
Set Clear Financial Goals:
- Align your ULIP and equity share investments with specific financial objectives, such as wealth accumulation, retirement planning or education funding.
- Clearly defined goals guide your investment strategy and risk tolerance.
Regularly Monitor and Reassess Risk Tolerance:
- Periodically evaluate your risk tolerance as your financial situation evolves.
- Adjust your ULIP and equity share investments to maintain a stability between risk and potential returns stability.
Disciplined Investment Approach:
- Avoid making impulsive decisions based on short-term market fluctuations.
- Maintain a long-term perspective to ride out market volatility and benefit from potential growth in both, ULIPs and equity shares.
Conclusion
ULIPs and equity shares are attractive investment options that can help create wealth and achieve financial goals. However, they also involve certain risks that need to be understood and managed by the investors. By following the strategies mentioned above, investors can minimise the risks and maximise the returns from ULIPs and equity shares.
