ULIPs Vs Term Insurance + MF SIP Combo – A Psychological Approach

It has been a fad for Financial consultants, Advisors, ( Financial Planners  included )  to  always suggest a combination of a diversified Mutual Fund SIPs and a Term Insurance in lieu of ULIPs.  This combination, they feel, would be cost effective and  ideal investment vehicle to create a corpus. While doing so, this also takes care of any contingency by way of a life cover. There are a lot of calculations made to prove their points.

The intention  of this article is not ridicule the combination and lessen the importance of such a ‘deadly’ combination. However many (in my opinion) have not covered the psychological impact of such a combo. Let us split the two and deal with them separately to understand better.

Term Insurance :- No doubt that this is the cheapest form of insurance, which one should consider while covering the life risk. The logic is to pay a very small premium to have a very high life cover. At the end of the term there is no cash inflow for the individual and what he gets is only a life cover during the tenure. If the individual outlives the tenure, he gets nothing.

SIP :-  A monthly investment in a couple of SIPs  would go a long way in creating a corpus needed to meet the various financial needs of an investor over a period of time.  This also inculcates financial discipline, while increasing the probability of a higher corpus creation. So far so good…

While  simple mathematics tells us that this combination would work very well theoretically and helps an individual to meet their financial needs. May be , depending on the corpus generated, one can leave a sizeable legacy to their heirs too.

But in reality does it happen?  How many of SIP investors have had an average tenure of a long term , say 15 or 20 years ?. Even a causal check with the AMC’s reveal that the average tenure of an SIP is anything between 4 to 5 years and not beyond that.

Why this happens?  We all know that any MF SIP does not have a deterrent for the investor to continue to invest for the entire period. While the combination does wonders for the entire tenure, the basic question is that how many of investors do complete the tenure intended . Please note that the combo would miserably fail if one component ( Term Insurance ) runs for a longer tenure  while the other one stops ( or may be partially withdrawn/exited to book ‘profits’, etc., ) in 3 to 4 years time frame.

The basic reason for the SIPs to stop is because of the psychology of the investors. Recently, we have had very good examples right from Jan 2008 till March 2009 where the markets were see-sawing between 21K & 8K. The fear factor griped the investor’s minds and in turn they started to think whether they should continue the SIPs and  stopped the SIPs. Panic did the trick here.

In such a scenario, can the combination of SIP and Term Insurance work?

May not be…

Here is where the ULIP has a slight edge over the combo. In an ULIP, there is a strong deterrent for the investor to discontinue the premiums ( or say the investments ) .  Given the deterrent factor in ULIP, the investor stays invested for the entire term which seems missing in the MF SIP and Term Insurance  Combo.

I think this way the investors would continue to invest in both the components, at the same time, and may reach the corpus, albeit lower in value.

So, should one confirm that the Combo of Term Insurance and SIP would not work?

Not necessarily. May be if there is an  SIP which has the same deterrent factor as in an ULIP, and a longer tenure , say 15 to 20 years in line with that of the term insurance , this deadly combo would work.

Until then , I think ULIP has an edge over the combo, at least on the psychological and practical grounds .