UPDATED: 16 AUG 2017

While these are the two most common options for growing wealth, many Singaporeans remain unclear about the difference. Let’s clear things up.

Most Singaporeans use either unit trust funds or endowment plans for long-term capital gains (in plain English, that just means “to have a huge pile of money” at some point in the future). While these are the two most common options for growing wealth, many Singaporeans remain unclear about the difference. Let’s clear that up:

What is a Unit Trust fund?

A mutual fund is a Collective Investment Scheme (CIS), in which many investors pool their money to buy different assets. Depending on the fund in question, these assets can be stocks, bonds, gold, property, or a mix of all of them. A unit trust fund can even hold units of other funds.

Ultimately, the point is that all the fund’s investors will see a return on investment, when the fund manages to purchase assets that generate profits.

A fund decides what to buy or sell based on the direction of its fund manager. This is sometimes a human being, and sometimes a computer algorithm (i.e. a programme that automatically buys and sells based on market movements).

In return for the expertise of the fund manager, the investors pay a cut of the profits generated. This is called the expense ratio, which is used to pay the fund manager and also the cost of running the fund (e.g. advertising and administrative work).

What is an endowment plan?

On the surface, an endowment plan is looks quite similar. A group of people pool their money, and the insurer then invests the money to give them a return on investment. The cost of the endowment plan comes from the premiums, which are charged to each investor.

A part of the premium goes toward investing in various assets, while the other part goes toward paying the insurer. This cost is often referred to as the distribution cost.

However, there are many key differences. The most important ones are:

  • Endowment plans have a maturity date
  • Unit Trust funds have a benchmark index, endowment plans aim for an absolute return
  • Endowment plans include an element of protection
  • Endowment plans are simpler to understand

1. Endowment plans have a maturity date

Endowment plans have a maturity date, after which the investor will get a lump sum payout, and the endowment ends. Unit Trust funds don’t have a maturity date; you can stay invested for as long as you want (or as long as the fund lasts).

Most of the time, endowment plans are used to save money for a specific purpose. For example, if your child is six years old, you might purchase a 15-year endowment plan. This will give you a lump sum to pay for your child’s tertiary education, as the endowment will mature when your child reaches the age of 21.

Unit Trust funds can also be used this way, but it is more common for unit trust funds to be used to continually amass wealth, for long term goals such as retirement.

2. Mutual funds have a benchmark index, endowment plans aim for an absolute return

A mutual fund has a benchmark index, against which its performance is measured. For example, say a mutual fund uses the FTSE 100 as a benchmark index.

This means that, if the FTSE 100 gains three per cent, the mutual fund should also gain close to this amount. If the mutual fund were to gain 3.17 per cent, then it would have outperformed (beaten) the market. If the mutual fund were to gain only 2.96 per cent, then it would have underperformed.

Note that the same applies when the benchmark is negative. If the FTSE 100 has returns of negative two per cent, and the mutual fund delivers returns of negative 1.89 per cent, it has still outperformed the market – it didn’t lose as much as it should have.

With endowment plans, there is no benchmark index. Rather, the insurer projects a return (3.75 per cent to 4.75 per cent), and tries to deliver this return consistently. This is called an absolute return.

This means that, even if the endowment product manages to gain 12 per cent due to clever management, the investors will still only get 5.25 per cent. The excess money is retained, to ensure returns will not fall below 3.75 per cent even in bad times – this is how the endowment manages to keep returns are consistent.

3. Endowment plans include an element of protection

Most endowment plans are still insurance policies. While they may not provide the same level of coverage as a protection-oriented product, they still include features such as payouts to beneficiaries, in the event of the policy holder’s death.

Unit Trust funds are not about protection; they are purely about growing your wealth with good returns. As such, many people who rely on unit trust funds will also have to purchase term insurance.

4. Endowment plans are simpler to understand

Which is better?

The answer depends on the investors’ intenti. If you are saving for something important in 10 years, it’s best to stick to endowments with their more predictable results. If you are looking at retirement, many mutual funds are able to deliver better returns.

Realistically, you will probably need both endowment plans and unit trust funds (although at different times in your life). You can speak to our retirement experts at RAY ALLIANCE Financial Advisers., to find the right product for you at present (http://www.rayalliance.com).

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