If you are looking for a financial product that offers life insurance and investment benefits, you might have come across ULIPs or unit-linked insurance plans. ULIPs are hybrid products that allow you to allocate a part of your premium towards life cover and the rest towards various funds, such as equity, debt, or balanced funds, depending on your risk appetite and financial goals.
But how do you measure the performance of your ULIP investments? How do you know if you are getting a good return on your money? That is where the concept of absolute returns comes in handy. Let’s explain what absolute returns are, how they are calculated, and how they differ from others.
What are absolute returns?
Instead of learning what is ULIP alone, understanding their returns is crucial. Absolute return is the profit percentage that an asset achieves over a specified period. It is expressed as a percentage of the invested capital. For instance, if you put Rs. 1 lakh in a ULIP, and after one year, the value of your investment grows to Rs. 1.2 lakh, the absolute return is 20%. This means that your investment has grown by 20% over one year.
This return does not compare the performance of an asset to any other measure or benchmark. It only considers the gain or loss experienced by the asset or portfolio independent of any market activity. Absolute returns can be positive or negative, depending on whether the asset appreciates or depreciates.
How are absolute returns calculated?
The formula for calculating absolute return is:
Absolute return = (Present value – Initial value) / Initial value x 100
Suppose you put Rs. 1 lakh in a ULIP, and after one year, the value of your investment grows to Rs. 1.2 lakh, the absolute return is:
Absolute return = (1,20,000 – 1,00,000) / 1,00,000 x 100 Absolute return = 0.2 x 100 Absolute return = 20%
How do absolute returns differ from other types of returns?
Absolute returns are different from relative returns and annualised returns, which are two other common ways of measuring the performance of ULIP investments.
- Relative return is the return an asset achieves over a specified period compared to a benchmark or a peer group. Suppose you infuse Rs. 1 lakh in a ULIP, and after one year, the value of your investment grows to Rs. 1.2 lakh, while the benchmark index grows by 15%, the relative return is 5%. That means that your investment has outperformed the benchmark by 5%.
Relative return helps you to evaluate how well your investment is doing in relation to the market or the industry. However, relative return does not tell you how much money you have made or lost. It also does not account for the risk involved in the investment.
- Annualised return is the return that an asset achieves over a specified period expressed as a yearly rate. It considers the compounding effect, so the returns are reinvested and earn more returns over time. Suppose you invest Rs. 1 lakh in a ULIP, and after two years, the value of your investment grows to Rs. 1.5 lakh, the annualised return is 22.47%. That means your investment has grown at an annual rate of 22.47% over two years.
This return helps you to compare the performance of different investments over different periods. However, annualised return does not reflect the actual returns that you have received in a given period. It also assumes that the returns are constant and consistent over time, which may not be the case in reality.
How can you maximise the absolute returns of your ULIPs?
There are a few ways that you can maximise the absolute returns of your ULIPs, such as:
- Choose a ULIP that has low charges. This will ensure that more of your premium is invested in the funds and less is deducted for expenses.
- Choose a ULIP that has a high lock-in period. This will allow your investment to grow over a longer period and benefit from the power of compounding.
- Choose a ULIP that has a flexible fund allocation option. This will allow you to switch between different funds according to the market conditions and your risk profile.
- Choose a ULIP that has a partial withdrawal option. This will allow you to withdraw a part of your money in case of an emergency without affecting the continuity of your investment.
- Choose a ULIP that has a loyalty addition or bonus feature. This will reward you for staying invested for a long period and enhance your returns.
Absolute returns are a simple and effective way of measuring the performance of your ULIP investments. They show you the actual growth or decline in the value of your investment over a given period. They also reflect the impact of the charges and fees that are deducted from your ULIP investment.