It is a widely known fact that money invested in equities will generate far better returns in the long term than other instruments. But investing in equities comes with its own set of risks because of the volatile nature of these investments.

In an uncertain economic environment, people are increasingly looking at investments to maximise returns and also safeguard against life’s uncertainties. Unit-linked insurance products (Ulips) are one of the ways to achieve these twin objectives. Despite the apprehension surrounding these plans, it would be a good idea to consider them keeping in mind the return on investment along with insurance protection.

The problem most consumers face is choosing the right Ulip. Most of the time, these products are bought on the advice of the agent without ascertaining if the product suits a consumer’s needs or not.

The problem is compounded when consumers see that many funds have similar objectives. For example, if an investor’s objective is to preserve capital and gain returns, there are scores of funds that claim to do precisely that.

Therefore, it is imperative for customers to find out which type of product suits them and make a decision based on clear understanding of their needs and the product’s features.

Life insurers offer a wide range of funds with Ulips. However, they can be broadly divided into three categories:

Growth or aggressive funds: These funds invest a major part of their money in equities. Hence, these funds involve high risk. The objective of such funds is to provide capital appreciation in the long run.

Balanced funds: These funds invest an equal amount in equities and bonds. Since a significant part of the investment is in fixed-income bonds, the returns are low compared with aggressive funds. However, this also makes the funds less risky. The objective of such funds is to provide moderate returns by taking moderate risk.

Conservative funds: Such funds invest a major part of the money in bonds. Since bonds provide fixed returns, these funds are considered the safest of the three. The return also will be lower because of a higher proportion of debt investments.

Fund selection

Following are the three most important driving factors to choose the right category:

Investment horizon for your objective: Your choice of funds should represent your objective. If you have a medium-term goal (5-10 years), you can invest in funds that are conservative as these funds will ensure a decent return and no loss of capital.

However, if you want to invest for a longer term (more than 15 years), investing in an aggressive fund is advisable as these funds have a better chance of doing well in the long term.

Balanced funds are ideal for investors with a mid (10-15 years) to long-term investment horizon.

Your age and risk taking capacity: A younger person has a longer investment horizon and higher inherent “risk taking capacity” and, hence, can afford to invest a larger portion of his or her savings in growth/aggressive funds. An older person would rather invest in conservative funds to preserve his capital.

Typically, a 30-year-old person should invest 60-70 per cent of his/her money in equity-oriented funds, while a person of 50 years should invest 50-60 per cent in conservative funds.

Your risk appetite: The appetite for risk may differ from person to person, irrespective of the age or the life stage of an individual. Even a young investor who is not comfortable with volatility and is risk-averse should not invest a majority of his savings in equity funds.

Countering volatility

Life insurers offer various mechanisms to ensure that the impact of volatility can be reduced.

One such mechanism is “systematic transfer of funds”, which ensures that the consumer’s investment hits the market in 12 equal installments. It works on the concept of “rupee cost averaging” and, thus, makes the volatility in the market work to one’s advantage. This ensures the purchase of more units for the same amount at lowered prices, thus lowering the average purchase price.

Another mechanism to contain the impact of volatility is “dynamic fund allocation” which enables an automatic rebalancing of portfolio, keeping in view the risk appetite of the customers at different stages of life.

Under dynamic fund allocation, the premium paid by the customers and the policy fund are dynamically allocated in debt and equity at a pre-determined percentage in the pre-determined funds based on the years remaining for maturity. This helps strike a right balance between risk and return throughout the policy tenure.

Deciding to invest in the right fund is a function of one’s risk profile, financial condition, understanding of the nitty-gritty of financial instruments and planning with an objective in mind.

Ulips are a great way to build wealth for passive investors who either do not have the time to study the markets nor have enough knowledge to take buy or sell decisions. This route can be used to build wealth and happiness over the long term.

The author is head of products solutions management, Max Life Insurance