In today’s investment scenario, there are various ways of reviewing the returns from an investment plan. One popular method is calculating the CAGR or the compounded annual growth rate. As one credible investment site explains, it refers to the mean annual growth rate of an investment over a specified period of time. However, for a beginner investor, the CAGR may seem a bit complicated. This is where the concept of absolute returns comes into view. This is a much simpler way of calculating the returns that your investment has gained since its initial investment. In this article, we take a look at how the concept of absolute returns works within a ULIP plan.
What is a ULIP policy?
Let us first understand what a ULIP policy is and how it functions. ULIPs or Unit-Linked Insurance Plans are essentially life insurance products with an investment element attached to them. Within these plans, one can invest in a range of fund options. There are equity funds, debt funds, and hybrid funds. One can opt from amongst these as per their risk-taking capacity. Life insurance coverage of a ULIP also forms an important arsenal against the unpredictable turns that life can take. Thus, ULIPs provide the insured policyholder with the best of both worlds.
You can also use tools such as the ULIP calculator to create a ULIP plan within your budget that suits your needs. Even though the calculator accurately estimates the returns, the actual results might vary. Understanding the concept of absolute returns may help in getting an idea of how well your money has actually performed.
Understanding absolute returns
When one invests in a market asset, they either receive gains or suffer losses. The asset thus undergoes appreciation or depreciation in monetary terms. Absolute returns refer to the results achieved by an asset invested in the market within a given time. The results can be positive or negative. Put simply, absolute returns refer to the shift in the value of the investment in comparison to its initial amount without taking into consideration any other aspect of the investment.
Absolute returns are calculated by taking into consideration the ULIP NAVs (Net Asset Value) of the fund at the initial phase and the current phase. The absolute return figure is expressed through a percentage of the initial principal amount or NAV.
Let’s take an example to understand this better:
You invested Rs 50,000 in a ULIP plan. Over a period of 5 years, the initial amount has reached Rs 75,000. If one does not look at any other factors such as ULIP charges, then the value can be said to have increased by 50%. Thus, the absolute return for this ULIP investment is 50%.
Merits of absolute returns
Provides a simpler approach
For a beginner investor, the concept of absolute returns is much simpler to understand. Though it is not the only factor they should consider, it does provide a brief peek into the performance of the fund. Once the investor finds that the absolute returns for a ULIP have been positive, they are keener to dive deeper into its nuances.
Perfect for short-term goals
If you are looking to secure a certain amount within a particular amount of time, then absolute returns can be of help. Since they offer a clear percentage of the expected return, you can take the figure into consideration when planning funds for a short-term goal. The estimates provided by the ULIP calculator are done so keeping the absolute return calculation in mind.
Demerits of absolute returns
Does not offer any compounding insights
Absolute returns are not helpful if one wants to understand the effects of compounding on their funds. Since they only consider the initial NAV and the current NAV, it becomes difficult to understand how much money has been earned via compounding each year, as is possible with CAGR.
Takes minimal factors into consideration
When calculating absolute returns, major factors, such as the ULIP charges, are not taken into consideration. Some of these charges are often levied after the money has already been invested. Hence, they do not come under the principal amount. Since the NAV is also calculated after deducting these charges, they do not factor into the absolute return calculation at all. This can create a misperception in the investor’s mind about how much they need to invest to earn a certain percentage of returns.
One must exercise caution and look at any investment option with a comprehensive lens before investing. When executed with the right amount of knowledge, a ULIP can be an immensely rewarding option.