Whether you are a seasoned or first-time investor, a mutual fund is something you should seriously consider adding to your investment portfolio. However, you should be aware of the advantages as well as possible pitfalls of this investment.
Listed below are the advantages and disadvantages of mutual funds to help you make an informed decision.
1. Advantages of Mutual Funds
Unless you opt for close-ended mutual funds, it is relatively easier to buy and exit a mutual fund scheme. You can sell your units at any point (when the market is high). Do keep an eye on surprises like exit load or pre-exit penalty. Remember, mutual fund transactions happen only once a day after the fund house releases that day’s NAV.
Mutual funds have their share of risks as their performance is based on the market movement. Hence, the fund manager always invests in more than one asset class (equities, debts, money market instruments, etc.) to spread the risks. It is called diversification. This way, when one asset class doesn’t perform, the other can compensate with higher returns to avoid the loss for investors.
c. Expert Management
A mutual fund is favoured because it doesn’t require the investors to do the research and asset allocation. A fund manager takes care of it all and makes decisions on what to do with your investment. He/she decides whether to invest in equities or debt. He/she also decide on whether to hold them or not and for how long.
Your fund manager’s reputation in fund management should be an essential criterion for you to choose a mutual fund for this reason. The expense ratio (which cannot be more than 1.05% of the AUM guidelines as per SEBI) includes the fee of the manager too.
d. Less cost for bulk transactions
You must have noticed how price drops with increased volume when you buy any product. For instance, if a 100g toothpaste costs Rs.10, you might get a 500g pack for, say, Rs.40. The same logic applies to mutual fund units as well. If you buy multiple units at a time, the processing fees and other commission charges will be less compared to when you buy one unit.
e. Invest in smaller denominations
By investing in smaller denominations (SIP), you get exposure to the entire stock (or any other asset class). This reduces the average transactional expenses – you benefit from the market lows and highs. Regular (monthly or quarterly) investments, as opposed to lumpsum investments, give you the benefit of rupee cost averaging.
f. Suit your financial goals
There are several types of mutual funds available in India catering to investors from all walks of life. No matter what your income is, you must make it a habit to set aside some amount (however small) towards investments. It is easy to find a mutual fund that matches your income, expenditures, investment goals and risk appetite.
You have the option to pick zero-load mutual funds with fewer expense ratios. You can check the expense ratio of different mutual funds and choose the one that fits in your budget and financial goals. Expense ratio is the fee for managing your fund. It is a useful tool to assess a mutual fund’s performance.
h. Quick & painless process
You can start with one mutual fund and slowly diversify. These days it is easier to identify and handpicked fund(s) most suitable for you. Tracking mutual funds will not take any extra effort from your side. The fund manager, with the help of his team, will decide when, where and how to invest. In short, their job is to beat the benchmark and deliver you maximum returns consistently.
You can invest up to Rs 1.5 lakh in tax-saving mutual funds which is covered under Section 80C of the Income Tax Act, 1961. Though a 10% tax on Long-Term Capital Gains (LTCG) is applicable for returns above Rs.1 lakh after one year, they have consistently delivered higher returns than other tax-saving instruments like FD in recent years.
j. Automated payments
It is common to forget or delay SIPs or prompt lumpsum investments due to any given reason. You can opt for paperless automation with your fund house or agent. Timely email and SMS notifications help to counter this kind of negligence.
There is a general notion that mutual funds are not as safe as bank products. This is a myth as fund houses are strictly under the purview of statutory government bodies like SEBI and AMFI. One can easily verify the credentials of the fund house and the asset manager from SEBI. They also have an impartial grievance redressal platform that works in the interest of investors.
l. Systematic or one-time investment
You can plan your mutual fund investment as per your budget and convenience. For instance, starting a SIP (Systematic Investment Plan) on a monthly or quarterly basis suits investors with less money. On the other hand, if you have surplus amount, go for a one-time lumpsum investment.
2. Disadvantages of Mutual Funds
a. Costs to manage the mutual fund
The salary of the market analysts and fund manager comes from the investors. Total fund management charge is one of the first parameters to consider when choosing a mutual fund. Higher management fees do not guarantee better fund performance.
b. Lock-in periods
Many mutual funds have long-term lock-in periods, ranging from five to eight years. Exiting such funds before maturity can be an expensive affair. A specific portion of the fund is always kept in cash to pay out an investor who wants to exit the fund. This portion cannot earn interest for investors.
While diversification averages your risks of loss, it can also dilute your profits. Hence, you should not invest in more than seven to nine mutual funds at a time.
As you have just read above, the benefits and potential of mutual funds can undoubtedly override the disadvantages, if you make informed choices. However, investors may not have the time, knowledge or patience to research and analyse different mutual funds. Investing with ClearTax could solve this as we have already done the homework for you by handpicking the top-rated funds from the best fund houses in the country.