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While both these financial instruments serve investment purposes, they differ significantly in their core goals, risk profiles, and benefits.
In this article, we’re going to explore what each of them are, how they differ, and what sort of investors they primarily serve.
Understanding mutual funds
Mutual funds are run by fund managers and are geared towards capital appreciation. They pool investor money to buy a basket of assets like stocks, bonds, or a combination.
The value of your investment fluctuates with the market, aiming to deliver potentially higher returns over the long term. For most mutual funds, you could invest money as a lump sum or through an SIP.
The difference is that while the former is a one-time investment of any size, an SIP is usually smaller with regular, automatic investment repetitions.
Mutual funds usually carry higher risk because they invest in equities and other asset classes, most of which are more risky than government-backed bonds or treasury bills. These investments are tied to the market’s movements, which means that you experience losses when the market dips. At the same time, however, you also stand to gain when the market rallies.
What are annuities?
Annuities are essentially financial contracts with insurance companies designed to provide you with income, primarily in retirement. You invest a lump sum or make regular payments over time, and in return, the insurance company guarantees payments back to you, either immediately or at a set date in the future.
Think of it as a way to turn your savings into a predictable income stream. Unlike traditional investments like stocks or mutual funds, annuities offer lower risk because they come with principal protection (guaranteeing your initial investment back) in some cases. However, this stability often comes at the cost of potentially lower returns compared to the stock market.
The key benefit of annuities is the guaranteed income they can provide. This offers peace of mind, especially in retirement, knowing you’ll have a steady stream of income to cover your living expenses.
Which investment should you choose?
Deciding between mutual funds and annuities hinges on your financial goals and risk tolerance. If you prioritise long-term growth and potentially higher returns, mutual funds might be the better path. Think about allocating more of your capital to these instruments if you’re young and don’t have immediate financial contingencies.
On the other hand, if you value guaranteed income and security in retirement, annuities could be a good fit.
Differences at a glance
| Feature | Mutual Funds | Annuities |
| Goal | Capital appreciation and potentially higher returns | Guaranteed income stream, primarily in retirement |
| Risk | Higher | Lower (often with principal protection) |
| Liquidity | More liquid (shares redeemable on business days) | Less liquid (surrender charges for early withdrawals) |
| Income | Not guaranteed (may receive dividends from holdings) | Guaranteed income stream (through payouts) |
| Fees | Typically lower expense ratios | May have higher fees (sales charges, surrender charges, administrative fees) |
| Taxation | Capital gains tax on profits, dividends taxed as income | Tax implications vary depending on the annuity type |
Frequently Asked Questions
A single life immediate annuity from a reputable insurer might offer a payout rate around 6-8% per annum for a 60-year-old investor. This translates to a monthly income stream of roughly ₹67,000 (not including charges and commissions) for a 1 crore lump sum investment purchase.
Mutual funds offer flexibility. You can switch between funds within the same investment family to adapt to changing market conditions.
Surrender charges for early withdrawals from annuities can be significant in India. In the first year, surrender charges can be as high as 15-18% of the invested amount. These charges may reduce to around 10-12% in the second year and continue to decline gradually over a period of 5-7 years, eventually reaching zero.
While some annuities offer inflation protection features, not all do. Ask about cost-of-living adjustments (COLA) on your annuity payouts to your insurance or investment provider.
Profits from selling mutual fund units are subject to capital gains tax. Short-term capital gains (held for less than 1 year) are taxed at your income tax slab rate. The tax treatment of annuity payouts depends on the type of annuity and the purchase mode (lump sum or regular premiums).
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