The Differences Between Traditional Savings Plans, Unit Trust and Investment-Linked Policies (ILP)
Growing our wealth in the present day can be an intimidating task. With so many different solutions and resources available it may be overwhelming trying to decide which is the most suitable for our financial goals and risk appetite. Many people we know choose to take the easier way out by mimicking someone else’s strategies and actions, but is that the best way?
Before you dive into the different saving and investment tools, the first step is to always begin by building a habit of regularly setting aside money to save. Starting this good habit early in life will allow us to have a longer time frame to plan, achieve our financial goals and figure out what the best way may be for ourselves.
“Building wealth is a marathon, not a sprint. Discipline is the key ingredient. – Dave Ramsey”
While most of us begin our very first step saving in a bank, what matters is how we utilize this savings to enhance our wealth overtime. This can be achieved through many ways. In this article, we will be explaining the differences between the three common tools to grow your savings and kick-start your investment journey: Traditional Savings Plans, Regular Unit Trust Investments and Investment-Linked Plans. Let’s take a closer look at each of these solutions!
1. Traditional Savings Plans
A traditional savings plan, also known as an Endowment Plan helps you to save your money regularly in a disciplined manner for future life goals. They consist of two components, Guaranteed Returns and Non-Guaranteed Bonuses that are declared yearly. You simply set aside a regular savings amount on a monthly or yearly basis for a set policy term and allow the plan to compound and boost its value. Once these bonuses are declared, it gets locked into your plan and becomes guaranteed.
This allows you to accumulate compound interest over the years and enhance your initial capital outlay. Therefore, it gives you a peace of mind. At the end of the set period, the maturity value is paid out.
Here are some benefits and limitations of Traditional Savings Plans:
- Earn decent market returns through a lower risk instrument
- Capital is guaranteed at maturity for selected plans
- Yearly reversionary bonuses are declared and locked into the plan
- Usually unaffected by market fluctuations
- Usually requires a longer commitment period
- Less flexible & liquid compared to investments (e.g stock market, unit trust)
- No control over investment portfolio
2. Regular Unit Trust Investments
Unit Trust (UT) is a type of investment that pools together money collected from various investors which is then invested into assets such as Bonds and Equities, and managed by a Fund Manager.
This provides us with an opportunity to diversify our investment capital instead of undertaking the riskiest method of investing: “Placing all your eggs into one basket”. Another type of emerging investment service known as the Robo-Advisors also utilizes Unit Trust in its client’s investment portfolio. “However, some Robo-Advisors platforms may lack the flexibility to fully customize to an investor needs due to the lack of human interactions for advisory matters.”
Example: If you wish to purchase a stock from company T and is afraid of the potential investment risks in placing all your eggs into one basket, you can purchase a Unit Trust fund that has a percentage of stock from company T and many others in its holdings. By having a broader market exposure, you can effectively reduce your risk through diversifying your investments across multiple industries, regions and asset types.
The image below briefly illustrates how a fixed amount of money invested can have an impact in the 2 different investment scenarios.
Unit Trust investments are usually invested as a single lump sum or encouraged to be invested on a regular basis to take advantage of the concept “Dollar Cost Averaging”. Let’s look at the illustration below:
For illustration purpose only.
Click above image to enlarge.
Here are some benefits and limitations of Unit Trust Investments:
- Flexible and liquid, you can access and withdraw your investments at any time
- Wide choice of funds for you to diversify your investment portfolio
- Managed by professional Fund Managers
- Full control of your investment strategy as you have unlimited fund switches
- Less certainty due to market fluctuations
- Investment capital is not guaranteed and investment returns is dependent on market fluctuations
- Returns may not be absolute due to annual charges involved
3. Investment-Linked Plans
An investment-linked policy (ILP) is a financial product that is a combination of investments with certain life insurance coverage. While starting your investment journey with an ILP, not only does it help you to achieve your investment goals, it also allows you to stay protected with minimal insurance protection against unforeseen circumstances.
With an ILP, the premiums collected are used to purchase units under a list of funds. This is usually recommended by your financial consultant. You can choose to invest in one or multiple funds. Unlike a traditional savings plan where the investment strategy is determined by the insurers through their participating fund, an ILP enables you to choose your investments from a wide range of funds that matches your investment objectives, time horizons and risk profile.
ILPs and Unit Trust investments may seem similar, but why do some people prefer investing through an ILP than simply investing in Unit Trust investments? Here are the main differences between the two:
- ILPs typically have a minimum investment period whereas a direct investment in a Unit Trust does not require a minimum investment period.
- There’s a minimum holding period for your funds in an ILP. This is usually because when one decides to invest through an ILP, their plans are credited with additional Bonuses which are used to purchase additional bonus units of their selected funds.
- For retail investors like most of us, an ILP allows us to partake in Accredited Investor Funds. This is one of the benefits of investing through an ILP.
Let’s address the definition of an Accredited Investor (AI).
To be qualified and considered as an Accredited Investor, the following criteria is necessary for an individual:
- Net personal assets exceed $2 million in value.
- Income is more than or equal to $300,000 in the preceding 12 months.
Any normal investment platform does not usually offer a non-Accredited Investor access to AI funds due to its complexity, investment risks and the high capital outlay required. Therefore, for people who wish to invest in such class of funds with minimal capital outlay (as low as $200-300 per month) may do so through an ILP.
Here are some benefits and limitations of Investment-Linked Plans:
- Most ILPs comes with initial welcome bonus and loyalty bonus to purchase additional investment units
- Wide range of funds for you to diversify your investment portfolio
- Allows you to make partial withdrawals to meet ad-hoc financial commitments whilst continuing your investments without much disruptions
- Full control of your investment strategy as you have unlimited fund switches
- Similar to Unit Trust, your investment capital is not guaranteed and investment returns is dependent on market fluctuations
- Minimum contribution period required
- Lock in period
Conclusion – How Do I Decide Which Is Most Suitable For Me?
While all investment instruments come with their own merits and risks, every individual has different goals in their wealth accumulation journey. Some of us have a longer term horizon for life stage goals such as retirement or kid’s education, some of us seek short term returns.
While there is no one solution that fits all, it is important to make informed decisions and ensure that you are able to take the risks that come with certain investments should you wish to proceed with them.
Start your savings journey by utilizing our Wealth Accumulation Suitability Quiz & Solutions Guide to find out which is most suitable for you at this point in time. Download our guide HERE and begin changing your life today!
The writers are financial adviser representative representing GEN Financial Advisory Pte Ltd.