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Wednesday, May 30, 2012

Should you Exit your ULIPs Now?


The title is a Million Dollar question isn’t it? The economic uncertainty in the Euro Zone and USA has affected the Stock Markets worldwide. Markets like India which attract a significant portion of foreign investors are highly sensitive to cash inflows & outflows from the markets. The past 2-3 years have been very strenuous on the Indian Stock Markets. We have witnessed multiple corrections & dips along with a few bursts of growth as well. At this Juncture, many of you, who had bought ULIPs in the past few years, might be wondering what to do with these products. Are you one of them? If so, this article is just for you…

Should you Exit your ULIPs now?

Well, this questions can’t be answered in a simple Yes or No across the board. We are going to split our investor population into two groups and answer this question depending on the situation they are in.

Category 1 – ULIP is less than 5 years old

These are the relatively new investors who have been investing in ULIPs only in the past few years. ULIPs as you might be aware are long term investment options and they also include high fees & charges during the first 2 – 3 years of its life. So, even if the stock market performs very well, a well-managed ULIP will reach the break-even point only around the 5 year mark. For ex: If you were investing 1 lakh every year, in all probabilities your investment will be worth around 5-6 lakhs by the end of 5 years even if the ULIP is performing exceptionally well.

In the last couple of years, the market has witnessed severe corrections and hence the value of your investment right now will be at least 10 to 20% or more lesser than what you had invested.

Moreover, Insurance Cos charge penalties if we withdraw our investments within the first 5 years (3 or 7 in some cases). So, at this point when the market is very volatile, exiting the investment would mean incurring losses. It would be advisable to stay invested and continue for at least a few more years and then reconsider your decision when your investment is 7 years old.

A 1 lakh investment every year will be worth the following amounts if it were to grow at different rate: (Invested Amount = 7 lakhs)
1. Growth @ 5% p.a = 8.5 lakhs
2. Growth @ 6% p.a = 8.9 lakhs
3. Growth @ 8% p.a = 9.6 lakhs

As you can see, if your investment grows at an average of 6% p.a rate of interest for those 7 years it will be worth 8.9 lakhs.
If you are in need of the money and your investment has grown by at least 6% on an average, it would be a good idea to exit the investment. But, until then, staying invested would be the best way to go.


Category 2 – ULIPs are More than 5 years Old

These are the Seasoned Investors who have been investing regularly for more than 5 years and by now are sitting on a handsome corpus (Assuming that their ULIP scheme has performed well). They have most probably crossed the mandatory holding period and can exit the investment anytime they want.

In the current market scenario exiting would make sense if:
1. You have some plans for the money you will get – Either to spend it on some cause (like children’s education, buying a home etc.) or to invest in some other instrument (like Bank FDs, PPF etc.)
2. Your Investment has grown at at least 6-8% or more on an average
Let’s take the same example where we invest 1 lakh every year. If our investment were to grow at 8% per annum it will be worth the following amounts:
a. At the end of year 6 = 7.9 lakhs (Investment = 6 lakhs)
b. At the end of year 7 = 9.6 lakhs (Investment = 7 lakhs)
c. At the end of year 8 = 11.4 lakhs (Investment = 8 lakhs)
d. At the end of year 9 = 13.4 lakhs (Investment = 9 lakhs)
e. At the end of year 10 = 15.6 lakhs (Investment = 10 lakhs)
So, if your investment has grown to approximately the amounts mentioned above, it would be a good idea to exit the investment right now. If your investment has only grown to be less than this, then the judgement call is yours. You can decide to exit the fund based on the current returns it has offered or opt to stay invested.

What about cases where we have crossed 5 years but the Investment isn’t worth even the amount we invested?

Did you think about asking me this??

Well, if so, the answer is – Stay Invested but do not make any fresh investments. Let’s say you have invested 1 lakh each year for 7 years and your ULIPs value right now is 6.5 lakhs, then don’t exit right now. You are at a loss of 50k and there is no point in exiting at a loss. So, you can do the following:
1. Stop making fresh investment contributions. Let us now add more money on a fund that hasn’t performed so well in the past 7 years or so
2. Don’t exit the fund. Let the investment of 7 lakhs stay as it is.
3. Switch your units to a Balanced option that invests equally (around 50%) in both Equities & Debt instruments to cushion & minimize further losses
4. Keep track of the ULIPs performance on a regular basis – say every month. Wait for the time when your investment breaks-even.
5. Give the fund another 6 months to 1 year to generate returns for you and the moment your investment is grown by at least 7-8% on a year-on-year basis exit the investment

A General Suggestion to all ULIP Investors

Irrespective of which category you fall into, whether you want to exit your investment or stay invested, whether you are going to make fresh investment contributions or not, the following suggestion will have a big impact on your funds risk/return ratio.
Most ULIPs give you options to switch between various investment options. At the given market scenario, being heavily exposed to the stock market is not a good idea. At the same time, too little exposure would be bad too because the market is sure to rebound and if you are in defensive mode when the market gets back on its feet, you will not get the growth or returns you want.
Switch Over to a Balanced Fund Option that invests equally in both Equities & Debt Instruments.
So, go for a Balanced fund option that invests around 50% or so in Equities and Debt Instruments. This way, at least 50% of your corpus is set up to be safe and the remaining 50% can help you attain good returns once the market recovers.

Happy Investing!!!

3 comments:

  1. Excellent advice and writeup!
    thank you!

    ReplyDelete
  2. I had ULIP in sbi wealth builder of ₹50k. I want to stop the policy. Its been less than a year. Is it right time to exit?

    ReplyDelete
    Replies
    1. If you exit during the first year, you will lose almost all your investment. Just remember that before you decide

      Delete

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