Insurance vs Mutual Funds: Know the Difference

With the equity markets experiencing an upswing, especially in the mid-and small-cap categories, investors have been drawn towards them to gain better returns. However, an important thing to note is that too much concentration in a particular area raises the risk factor, and investors should remain well aware of this. 

It has also been noticed that there are a few other investment options, including insurance policies, that are often sold as those belonging to the mutual funds category. Investors are advised to remain watchful against such practices and check the exact details of the investment before deciding to park their money in such investment options.

Notably, insurance companies (insurers) who provide mid-cap and small-cap plans in their unit-linked portfolios are quite different from the normal mutual fund schemes. The difference between the two investment options is as follows. 

Not all small-cap funds are a mutual fund: Mutual funds offer small-cap schemes, and considering the sharp rally in the small-cap landscape, these funds have performed quite well from March 2020 onwards. Meanwhile, the term small-cap fund does not automatically imply a mutual fund offering.

Insurers offer unit-linked insurance policies (ULIP), which have a mixture of insurance and investment, as a part of the premium is allocated towards a fund. Ultimately, the performance of the fund will determine the payout on the policy. 

These policies also have a choice of funds, which could include large-, mid- and even small-cap funds. So, considering there is exposure to small-caps via such an option, it does not imply that the investment is a mutual fund. The entity that is offering the product needs to be looked into, and that will provide a better idea as to what the investment is in reality.

Gain insight into the allocation: This remains a crucial aspect of the entire investment; an investor should understand the actual investment and where it is going. Investing in a small-cap mutual fund ensures that the entire money is directed towards small-caps, as defined by the entities or companies beyond the top 250 by market capitalisation (m-cap) in India. 

Conversely, when an investor takes exposure to a small-cap fund in a ULIP, the features of the policy have to be followed. This means that there will be a premium that goes towards mortality charges. Additionally, the various other expenses related to the policy will be deducted, and after this, the remaining amount will be invested in the fund.

Initiating the appropriate comparison: One more aspect that often misleads investors is the kind of comparison undertaken to highlight that there is a higher return earned by the small-caps.

For instance, comparing a large-cap index to a small-cap index over a period is most likely to highlight the small-cap index return being higher as compared to the former. This holds especially true over the last several years, wherein the small-cap space has performed relatively well.

However, this is not an appropriate comparison. It leads the investors to assume that this kind of situation is mostly likely to continue forever. The most crucial factor is risk because the risk element in large-cap equities and small-cap is completely different and could be tough for many investors to handle in the latter case.

As an investor, it is important to choose the right period for looking at performance in terms of market behaviour, which is also essential. This could otherwise lead to a scenario where the investment decision does not align with the correct factors.

Fund returns could not be the return of an investor: Generally, in the case of a mutual fund scheme, staying invested with the fund for a longer period will ensure that the returns that the fund earns turn out to be the returns of the investor. However, the situation changes for a ULIP scheme. 

In this, several other factors are at play, including expenses involved with the result, so much so that even though an investor may have exposure to the fund, the results they witness could be different.

Additionally, experts view that having a mixture of insurance and investments in a single product is not a suitable investment idea. Ideally, it is always better to separate the two. As an investor, any investment-related decision should be based on appropriate information, and one should remain watchful against being misled.