Last Updated on May 25, 2022 by Neera Bhardwaj
Mutual funds invest pooled capital of investors in various asset classes according to the objective of the fund with the goal of capital appreciation. It is hyped as a great alternative to direct equity investment where a fund manager takes care of your money.
Irrespective of whether you are a new investor or a seasoned one, mutual funds are great value additions to an investment portfolio. But this is as long as the investor has the risk appetite and the objective of the fund serves the purpose towards achieving the investor’s financial goals. That said, one must be aware of the advantages of mutual funds and the disadvantages of mutual funds to actually be able to assess product suitability for investment. This article explores just this to help you understand if mutual funds will work for you.
Table of Contents
What are mutual funds?
Mutual funds pool money collected from many investors and invest it in various asset classes like equity, debt and commodity. The portfolio of a fund is diversified, well-structured and is maintained to be in line with the investment objectives as mentioned in its prospectus to the investors.
Each subscriber to the fund owns shares of the fund, called units, which represents part of the holdings. As the value of the assets the fund invests in grows, the value of the portfolio of the fund grows and so does the unit price of the fund, also called the Net Asset Value (NAV).
Advantages of mutual funds
The mutual funds industry has blossomed into a multi-billion industry with investor education and awareness shepherding investors towards the product. The advantages of investing in mutual funds are aplenty, a few of which are listed below:
Professional management
Mutual funds are managed by experienced, skilful and professionally qualified managers. They analyse the stock market and other investment options and strive to bring in higher returns for their clients.
Diversification
Mutual fund portfolios span across several companies operating in various industries that help mitigate the concentration risk in the portfolio. This is one of the biggest advantages of a mutual fund, that in case one stock or equity as an asset class is not performing well, the risk can be brought down by the other stocks or debt as an asset class that is doing fairly well.
Reinvestment of income
Mutual funds generally give the option of reinvestment of income wherein the money compounds in the investment adding to your corpus in the longer duration.
More liquidity
It is fairly easy to get in and come out of a mutual fund scheme. Most mutual fund schemes do not have a lock-in period like fixed income products. They are liquid investments, meaning, they can be converted to cash quickly. Note that some funds may levy a small exit load if an investor redeems the units before a fixed period from purchase.
Benefits of taxation
While there are no specific tax benefits to investing in mutual funds, the profits being subject to long term capital gains tax and short term capital gains tax, there is a type of mutual fund that is aimed at tax-saving itself. Equity Linked Saving Scheme (ELSS) allows tax deduction up to Rs 1.5 lakh under Section 80C of the Indian Income Tax Act, 1961.
Convenience
An advantage of mutual funds is that it is a simple product that is easy to invest in. That is also the reason for the popularity of the product among investors. A mutual fund can be purchased online or offline, and directly from the mutual fund, or through a broker or an agent. Redemption also works in the same way.
Flexibility of investment
It is the investors’ choice to invest as a one-time lump sum or in a Systematic Investment Plan (SIP) as per their budget and convenience. The investors also get to choose the kind of mutual fund they want to invest in, the duration of investment (in majority cases) and the date of recurring deposits in case of SIP. An investor may also choose to redeem on the day of their choice.
Invest in small denominations
A big advantage of a mutual fund is that investment can be made in pocket-friendly amounts too. An investor can make a SIP instalment for as low as Rs 500.
Now that you’ve looked at the advantages of mutual funds, let’s look at the flip side – the disadvantages of mutual funds.
Mutual funds help in investing small denominations and provide diversification as they can help reduce the risk in the portfolio Click To TweetDisadvantages of mutual funds
It is advisable to analyse the advantages and disadvantages of investing in mutual funds before making a final choice. Few disadvantages of mutual funds are listed below:
No control over portfolio
One disadvantage of a mutual fund is that the investor has no say as to where to invest. This decision is made by the fund managers.
Portfolio overlap
Too many mutual funds in the portfolio may be counterproductive to the diversification goals of the investor. For example, there is a high possibility that most largecap funds invest in similar stocks from the largecap universe.
Cost of investment
Some mutual funds may charge an entry and exit load in addition to the expense ratio. These charges may affect the overall returns earned by the investor.
Redemption timing
Unlike shares and securities, mutual funds can be sold only at the closing price for the day at the end of the trading session. That is when the NAV of the fund is updated.
Fluctuating returns
As in the case of equity investments, in the case of mutual funds too, there are no guaranteed returns as all market risks prevail in all mutual fund investments.
Mutual funds make it easier and convenient for the investors to get exposure to equity markets but safely from behind a wall. Investors need not monitor the market by the minute and fret over timing the market. A professional fund manager appointed by the AMC is available to do the footwork for your investment. A careful selection of mutual funds and looking for low-cost options can help in diversifying across market segments through a single investment while also avoiding high fund fees and sales commissions. Analysing the advantages and disadvantages of mutual funds helps in making a better choice.
