It’s a pity that investors are withdrawing money from mutual funds. Most new funds launched in...
New products, regulations, features and options, interpreted from your perspective
Big dream, low return
Since the Insurance Regulatory and Development Authority (IRDA) started clearing unit-linked insurance plans (ULIPs) according to the revised regulations, new and improved ULIPs are flooding the market. Birla Sun Life Insurance (BSLI) unveiled 'two non-participating' ULIPs - BSLI Dream Endowment Plan and BSLI Classic Endowment Plan. As with other ULIPs, these new products also claim to offer customers 'a balance of savings and protection'. But they actually offer very low returns. By our estimates, you will earn not more than 6%-7%, almost similar to bank fixed deposits.
BSLI Dream Endowment Plan promises a guaranteed savings amount on maturity. But this amount (the company does not say how much) will, in all likelihood, be more than eaten up by high inflation, especially in urban areas. BSLI Classic Endowment offers a self-managed option that provides customers access to BSLI's suite of 10 investment funds, allowing them freedom to switch between its funds by allocating 5%-100% of the premium, in varying proportions, according to their risk appetite.
These policies come in different flavours: Income Advantage, Assure, Protector, Builder Plans, Enhancer, Creator, Magnifier, Maximiser, Multiplier and Super 20. But, in practice, these choices are neither useful nor relevant. Investors can also opt for an additional sum assured while buying a policy, and pay a top-up premium of Rs5,000 that will be added to their basic premium. The policy comes with five riders like BSLI Accidental Death and Disability Rider, BSLI Critical Illness Rider, BSLI Surgical Care Rider, BSLI Hospital Care Rider and BSLI Waiver of Premium Rider.
The policy carries a 7.50% premium allocation charge in the first year; 6.50% in the second year; 5% from the third year onwards; and 2% will be charged on any top-up premium. BSLI will charge 1% per annum as fund management fee for Income Advantage, Assure, Protector and Builder Plans. Enhancer and Creator carry a 1.25% management fee, while Magnifier, Maximiser, Multiplier and Super 20 carry a 1.35% charge. Remember, all charges are fixed (whether the investment gives any returns or not) and will eat up a large part of the returns.
More of the same
SBI Life is offering SBI Unit Plus Super, available in nine options: Index Fund, Equity Fund, Top 300 Fund, Equity Optimiser Fund, P/E Managed Fund, Growth Fund, Balanced Fund, Bond Fund and Money Market Fund. The scheme is almost identical to BSLI's products.
The Index Fund will track the S&P CNX Nifty Index; 90% will be invested in equity and 10% in cash and money-market instruments. The Equity Fund will invest 80% in equity and the rest in debt and money-market instruments. The Top 300 Fund will focus on the top 300 stocks based on market capitalisation on the National Stock Exchange (NSE). The Equity Optimiser will invest 60%-100% in equities and up to 40% in debt and money-market instruments. The P/E Managed Fund will make investments based on the forward price/earnings ratio of the S&P CNX Nifty Index. The Bond Fund will invest 60%-100% in debt and up to 40% in money-market instruments and the Money Market Fund, as the name suggests, will invest mainly in money-market instruments and a small portion in debt.
The policy has four rider benefits, like Criti Care 13 (that covers 13 critical illnesses), an accidental death benefit-linked rider, a Premium Pay Waiver Benefit and Income Sustainer Rider (early death or permanent disability benefits).
Investors have the option to switch a minimum of Rs5,000 between the nine funds, twice during the term of the policy free of charge; more than two switches will involve a charge of Rs100 per switch. Unused switch options will not be carried forward. The regular premium policy carries 9% fund allocation fees in the first year, 6.50% for the second and third years, 6% for the fourth and fifth years, 3.50% during the sixth and seventh years and 3% until the 10th year.
Single premium policyholders will have to pay only 3% as fund allocation charges in the first year. There will be no fund allocation charges thereafter.
The Equity Fund, Top 300 Fund, Equity Optimiser Fund, P/E Managed Fund and Growth Fund carry 1.35% fund management charges. The Balanced Fund, Bond Fund and Money Market Fund carry 1.25%, 1% and 0.25% charges per annum, respectively.
Not so smart a performer
SBI Life Insurance has also floated a plan called SBI Smart Performer which claims to offer 'Higher than the Highest' NAV. It comes with two options - a Secure Plan and Secure and Growth Plan.
The entire corpus of the premium of the Secure Plan will be invested in a 'daily protect fund'. Investors will get returns based on the performance of this Fund and the underlying guarantee. In the Secure and Growth Plan, 80% of the premium will be invested in a 'daily protect fund' and 20% in an index fund that tracks the S&P CNX Nifty Index. The Secure and Growth Plan offers an auto-rebalancing facility. If the money invested in the index fund appreciates or crosses 15%, these gains will be put into the daily protect fund to secure the gains.
This facility is available only for the first six years of the policy term. If the gains do not reach the 15% mark, investors' wealth will be further eroded due to a high tracking error.
The daily protect fund claims to offer 5% higher than the highest guaranteed NAV in the first seven years, or the prevailing NAV at maturity, whichever is higher. The Fund will further charge 0.50% per annum on the daily fund value, by cancellation of units on a monthly basis, to provide the guaranteed NAV. The sum assured is ten or seven times the annual premium, depending on the policyholder's age. The Fund will invest in equity and debt.
The term of the policy is 10 years. It will charge 8.50% for premium allocation in the first year, which will be reduced to 6% from the second to the fifth years. If one takes into account the high charges, the returns will be almost similar to those of a debt fund! These so-called highest NAV products aim to lure gullible investors by concocting confusing methodologies.
Full cover on purchase price
Bharti Axa General Insurance has introduced an add-on insurance product for car owners that will give them the full purchase price of the vehicle, in case of theft or loss, in the first two years after the purchase. This will also cover the road tax and first-time registration charges that a buyer would incur on the vehicle.
This add-on product, called the 'invoice price cover', will be available with the company's motor insurance product, SmartDrive Private Car Policy. Most insurance companies provide cover on the depreciating value, which varies from 20% to 30% in the first two years. This product will enable customers to avail of cover which is equivalent to the purchase price of their vehicles.
After two years, the cover will be based on the normal depreciating value. Motor insurance premium constitutes 3.5% of the car value. The add-on product would increase the premium by 0.25%-1.25% of the value of the vehicles.
We look at some crucial details regarding mutual fund investments, why insurance should not be considered an investment and why investors tend to make mistakes
Common misconceptions about mutual funds
Most investors prefer to invest in mutual funds (MFs) rather than trying their hand at picking individual stocks. However, investors still have some misconceptions when it comes to investing in mutual funds, resulting in a poor choice of schemes. Let us look at some of these misconceptions and examine how we can deal with them.
More funds mean more diversification
Unfortunately, some investors think that 'the more, the merrier' applies to MF schemes also. It is not uncommon to find a bagful of them in an investor's portfolio. They believe that owning a spectrum of MF units would broad-base their holdings and offer better diversification. However, all they are doing is buying the same securities under different schemes. This only results in severe dilution in performance. Ideally, investors should not have more than four to five schemes in their portfolio.
NFOs (New fund offers) yield better returns than existing schemes
This is a fallacy that many investors fall prey to. Since the first net asset value (NAV) declared by a fresh fund scheme is low, people tend to assume that the scheme units are cheap. Nothing can be farther from the truth. A new scheme issued at Rs10 does not imply that it will yield better returns than an existing scheme with a higher NAV. It does not matter whether the new fund is being issued at an NAV of Rs10 or Rs1,000. New fund offers (NFOs) by mutual funds should not be confused with initial public offers (IPOs) of companies, which provide better scope for generating high returns. The NAV merely reflects the market value of the stocks held by a scheme as on that date. A scheme with a higher NAV can give better returns than one with a lower NAV, if its stocks perform better in the market.
Comparing funds on returns since inception
Investors often compare the performance of mutual funds based on their returns since inception. However, such a comparison is futile because all mutual funds do not have the same inception date. As such, their returns vary depending on the timing of their launch and the period of existence. For instance, comparing the returns since inception of two funds launched in 2002 and in 2007 would be inappropriate. The returns since inception should be considered only to determine a scheme's relative performance against its benchmark.
SIP is another investment avenue
Systematic investment plans (SIPs) are very popular among investors nowadays, and fund houses have stepped up their efforts to capitalise on this sentiment. Several investors believe that SIP is another investment avenue. SIP is a mode of investing in mutual funds and not a distinct product. Under an SIP, instead of making a one-time, lump-sum investment in a scheme, an investor makes regular investments at pre-determined intervals.
Why insurance should not be an investment
Confusing insurance with investment is a common error and insurance companies have made good business of a wrong notion.
Investors tend to shun pure insurance products in favour of 'insurance-cum-investment' products as they believe that pure insurance products give a raw deal. When somebody puts his money into a financial product, he expects something in return. This is not the case with, say, a term insurance policy, which only offers a fixed amount to the nominee in case of death of the assured. If one doesn't die, one doesn't get anything.
This is where the popular unit-linked insurance plans (ULIPs) come into the picture, as they offer something back to investors regardless of whether they survive the policy term or not.
Investors willingly take the bait as insurance companies sell these products aggressively, wrapping the protection in a variety of investment products which are sold through agents who earn large commissions on premium payments. Most often, these products are not purchased for their insurance benefits. Customers lose sight of the primary role of insurance. Insurance, in its purest form, is a way to provide for your dependents in case of your untimely death.
Even the chairman of the Insurance Regulatory and Development Authority (IRDA), J Hari Narayan, said in an interview with Moneylife recently that the insurance industry has made a mistake in marketing insurance as an investment. "It (life insurance) is a risk product; it is meant for safety and security; its fundamental principle is different. Maybe somewhere along the line, we lost sight of the fact that insurance is a risk cover. To confuse insurance with investment is a mistake. It would be unrealistic to expect insurance to give the kind of returns that one can earn from a well-managed investment," Mr Narayan said.
Indeed, ULIPs are investments and, therefore, should be judged against the returns offered by other investment products. They don't fare too well on this indicator. One of the reasons for poor returns is the alarmingly high expense ratio of these products. The big problem with such products is that an investor has to commit to an unsustainably high premium. Even with the recent changes in the cost structure of ULIPs, the impact of various charges like premium allocation charge, fund management charge, administrative charge and mortality charge, is enough to steadily erode your returns. In the process, you not only end up with low returns, but you are also left under-insured.
Tricks your mind plays
Why do many investors lose their way or end up making mistakes with their investments, when they actually aim to do better? The answer lies in psychology; often it is our mental make-up that leads us to make irrational decisions. Here are some examples.
Price Bias: We appear to be pre-programmed to equate price with quality. This often leads us to commit errors while picking stocks. Just as we tend to judge the quality of wine by its price tag, investors tend to apply this rationale in the stock market. So, the higher a stock price goes, the greater is our comfort. We seem to have an in-built dislike for items that may be available at a discount. Consequently, sound opportunities of investment in quality stocks, at bargain prices, are often ignored by investors.
Loss Aversion: Nobody wants to make a loss on one's investments. We dislike losses more than we enjoy gains. This causes us to hold on to our losing investments over a far longer period, instead of booking a loss and redeploying the money in better investments.
Herding: The herd mentality refers to the tendency of investors to react to market conditions based on what others are doing. It is social behaviour that reflects a contagious emotional, collective feeling which spreads progressively. It is what leads investors to panic and sell at market bottoms and buy at peaks. Very rarely do we see investors take contrarian positions, when the crowd is falling prey to emotions.
Overconfidence: People have overconfidence in their investment abilities. This overconfidence stems from an illusion of knowledge and control. The illusion of knowledge fosters the belief that because we know more, we must be able to make superior decisions. The illusion of control makes us believe that we have influence over things which we don't.
Present Bias: Short-term rewards are more cherished by investors than delayed gratification. Long-term horizons do not naturally come to human beings. The possibility of an immediate reward is far too attractive to ignore. That is why investors have a tendency to book profits at the slightest shiver and, in the process, lose out on long-term opportunities.