Advantages & Disadvantages of Mutual Funds

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.

Advantages of Mutual Funds

Liquidity

Unless you opt for close-ended mutual funds, it is relatively easier to buy and exit a mutual fund scheme. You can sell your open-ended equity mutual fund units when the stock market is high and make a profit. Do keep an eye on the exit load and expense ratio of the mutual fund.

Diversification

Equity mutual funds have their share of risks as their performance is based on the stock market movements. Hence, the fund manager spreads your investment across stocks of companies across various industries and different sectors called diversification. In this way, when one asset class doesn’t perform, the other sectors can compensate to avoid loss for investors.

Expert Management

A mutual fund is good for investors who don’t have the time or skills 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.

The fund manager and the team of researchers decide on the appropriate securities such as equity, debt or a mix of both depending on the investment objectives of the fund. Moreover, the fund manager also decides on how long to hold the securities.

Your fund manager’s reputation and track record in fund management should be an essential criterion for you to choose a mutual fund. The expense ratio (which cannot be more than 2.25% annualised of the daily net assets as per SEBI) includes the fees of the fund manager.

Less cost for bulk transactions

You must have noticed how price drops with the purchase of increased volumes. 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 mutual fund units at a time, the processing fees and other commission charges will be lesser as compared to buying one mutual fund unit.

Invest in smaller denominations

By investing in smaller denominations of as low as Rs 500 per SIP instalment, you can stagger your investments in mutual funds over some time. This reduces the average cost of investment – you spread your investment across stock market lows and highs. Regular (monthly or quarterly) investments, as opposed to lumpsum investments, give you the benefit of rupee cost averaging.

Suits your financial goals

There are several types of mutual funds available in India catering to investors across 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, time horizon, investment goals and risk appetite.

Cost-efficiency

You can check the expense ratio of different mutual funds and choose the one with the lowest expense ratio. The expense ratio is the fee for managing your mutual fund.

Quick and hassle-free process

You can start with one mutual fund and slowly diversify across funds to build your portfolio. It is easier to choose from handpicked funds that match your investment objectives and risk tolerance.

Tracking mutual funds will be a hassle-free process. The fund manager, with the help of his team, will decide when, where and how to invest in securities according to the investment objectives. In short, their job is to beat the benchmark index and deliver maximum returns to investors, consistently.

Tax-efficiency

You can invest in tax-saving mutual funds called ELSS which qualifies for tax deduction up to Rs 1.5 lakh per annum under Section 80C of the Income Tax Act, 1961. Though a 10% tax on Long-Term Capital Gains (LTCG) above Rs 1 lakh is applicable, they have consistently delivered higher returns than other tax-saving instruments in recent years.

Automated payments

It is common to delay SIPs or postpone investments due to some reason. You can opt for paperless automation with your fund house or agent by submitting a SIP mandate, where you instruct your bank account to automatically deduct SIP amounts when it’s due. Timely email and SMS notifications make sure you stay on track with mutual fund investments.

Safety

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.

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 in an equity fund suits investors with less money. On the other hand, if you have a surplus amount, go for a one-time lumpsum investment in debt funds.

Disadvantages of Mutual Funds

Costs of managing the mutual fund

The salary of the market analysts and fund manager comes from the investors along with the operational costs of the fund. Total fund management charges are one of the first parameters to consider when choosing a mutual fund. Higher management fees do not guarantee better fund performance.

Exit Load

You have exit load as fees charged by AMCs when exiting a mutual fund. It discourages investors from redeeming investments for some time. This indirectly works like a lock-in period that fund houses use to maintain stability of funds. It also helps the fund manager garner the required funds to purchase the appropriate securities at the right price and time.

Dilution

While diversification averages your risks of loss, it can also dilute your profits. Hence, you should not invest in many mutual funds at a time.

As you have just read above, the benefits 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 problem as we have already done the homework for you by handpicking the top-rated funds from the best fund houses in the country.

Frequently Asked Questions (FAQs)

Why invest in mutual funds?

Investing in mutual funds helps in wealth generation, safety of capital and regular income. Mutual funds can also benefit by diversifying your investment. You get expert management, tax savings benefits, liquidity, flexibility and convenience. Therefore it is considered as one of the best avenues for investment.

Can you lose money in mutual funds?

The profit and loss in a mutual fund are highly dependent on the underlying security performance and market’s performance. Therefore due to this volatility there is no assurance that you will not lose money in the mutual funds. Though experts recommend that before investing in them one should have a clear understanding on how mutual funds work.

What are the factors you need to consider while choosing the best mutual fund scheme?

Before choosing a mutual fund scheme one should look for the following factors like performance, AMC track record, the fund manager’s experience, performance against category, expense ratio, the scheme’s Assets Under Management (AUM), etc.

What is the best strategy for you to enjoy highest returns from mutual funds?

To enjoy highest returns you can go for high-risk options, carefully assess the investment objectives, and choose the right funds to diversify the portfolio. One can also opt for index funds that have lower charges as compared to actively managed funds.

What are the problems of mutual funds in India?

Although the mutual funds industry in India offers various schemes, there are certain problems. This includes low financial literacy, malpractices in trading, rising investors’ complaints, secrecy in documents, and others.

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