Fill it, shut it, and forget it – it is not the way most investments work! At least not the unit-linked plans that combine the best of both worlds. A newer generation product when seen with reference to conventional whole life and endowment policies, the ULIP plan serves as a dual purpose investment vehicle that serves the investor well in the long term. However, just as a car needs regular fine-tuning and maintenance, so is the case with this vehicle (of investment).

One of the reasons that people have not gone the ULIP way as much as they have adopted the shares and debentures or the mutual funds is because there are many charges levied on the purchaser of the ULIP. However, although not all but a few of the new generation ULIPs have started to become customer friendly and are looking to attain the coveted top performing ULIP funds in contemporary times.  This is possible because the investors need to be invested in them for the mid to long term. Hence, they see the fruits of the investment when they have been in the ULIP for a minimum of five years.

According to many stalwarts of the scene, ‘An investor needs to calculate returns and review the performance of the ULIP performance over the period that they have stayed invested in the plan. Experienced financial advisors do well to advise their clients to stay invested in the ULIP just like they stay invested in mutual funds or the insurance vehicle seen like an investment. However, unlike other vehicles for investment where there is no compulsion on the investor with regards to the period of investment, there is a fixed lock-in period of five years when you invest in a ULIP.

When calculating the returns on the ULIP plan investment, it would stand you in good stead if you are aware that the ULIP investment attracts some charges that are mandatory. This could be one of the reasons for its low popularity. As against this, there are certain investment types that do not charge a load or a fee either when you invest or when you liquidate. In such a case, where there are minimum number and types of charges, there is a huge rush of investors as against the ULIP where not only the charges but also the semi-literacy on the part of the agents or financial advisors.

The types of fees and charges which are normally deducted from ULIP are mortality charges, charges for fund management, charges for premium allocation, charges for policy administration as well as a surrender charge which is subtracted for partial encashment or complete premature encashment of units that have been purchased. Given below are two ways in which you can compute the ULIP performance or returns of the plan.

Absolute returns of ULIP

When calculating absolute returns of the plan, the only two numbers that they have to concern themselves about are the current NAV and the NAV at the time of purchase.  The absolute returns are also known as Point-to-Point returns. There is a formula that is deployed to calculate the value.

The formula is [(Current NAV – Initial NAV)/Initial NAV] ×100. 

This seems to be the most effective formula for calculating the returns on the investment. However, there is a drawback of this method. Although this formula can be used at any time in the duration of the investment, it works best in the initial phase of the investment. The prime reason being that this formula helps the investor to calculate just the simple interest on the initial investment. However, in the long run it becomes ineffective since the returns over the longer term are computed using the compounded interest formula since the interest of the previous year is added to the previous year and that is then used to calculate the interest on the next year and so on.

Compounded Annual Growth Rate (CAGR) of ULIP

When you have to compute the rate of returns of a vehicle of investment over a period of extended time, the Compounded Annual Growth Rate formula works the best. A policyholder can generally use the mathematical formula that is simple and straightforward enough to calculate the CAGR for a ULIP plan.

The formula is: {[(current value of NAV/initial value of NAV)^(1/number of years)] – 1}*100.

However, just as the case of the simple interest method of computing the rate of return on the investment, even the CAGR way of arriving at the value of the investment after a period of time is fraught with risks of miscalculating. The reason for this is that although it is more accurate than the simple interest method, CAGR doesn’t take into consideration certain critical factors that can be detrimental in deciding the value of the investment. One of those is the volatility of the market which is a critical factor that determines the rate of returns for any sort of investment. Hence, even if your favourite investment may have performed well over the preceding years, it shouldn’t be taken for granted that it will continue on the same path for the future as well.