Investment as a word is quite diverse and intriguing in itself. You get a plethora of options to choose from in form of equity to gold, bank deposits to bonds, money market securities and a whole lot of more. It does get confusing sometimes going through such an exhaustive list of options to choose from.
Among them, mutual funds are one of such convenient investment schemes that are often cited as a smart investment. A mutual fund is an investment security that allows the investors to pool their money into professionally managed investment consisting of stocks, bonds or a combination of both of these. With India embracing the concept of investing, options like stocks and mutual funds have been the new way of investing rather than relying on traditional means. This has seen a growth in the mutual fund industry and is becoming increasingly popular among masses in India.
The mutual fund comes forth with advantages like ease of use and the ability to invest in smaller denominations which makes it a good choice to opt for. But like other investment options it also comes with its own set of disadvantages alongside its advantages which we’ll be briefing down below here:
Advantages of Investing in Mutual Funds
Here are a few advantages of investing in mutual funds. Read along:
- Basis for diversification: The market is quite dynamic and fluctuating. You can never predict the way the market will turn out accurately every time which in turn makes it confusing for any willing investor whether to put their money into the market or not. This is where the mutual funds can be a good investment option as rather than investing in a single asset they form a portfolio consisting of different classes of assets like equity, debts, money market instruments and more. This diversified portfolio helps to reduce the risk of losing out money by spreading your risk over different asset options. So, even if one of your assets doesn’t perform as anticipated, the losses would be compensated from the higher yield generated by other assets.
- Handled by professional fund managers: Most of the people even though they are willing to invest in the market stay away from it due to a lack of necessary knowledge. For a commoner who is preoccupied with work and other responsibilities, finding time to research and study the market trend can be a cumbersome task. This is why mutual funds have become a preferred means over direct equity options as they are handled by professional fund managers who can manage your funds on behalf of you. Mutual funds are managed by professional fund managers who are well-tuned to the changing market dynamics and are experts in the field. These fund managers monitor the market regularly and will regularly update your portfolio by buying and selling the funds on your behalf to create maximum value for your investment.
- Liquidity: Mutual funds allow you an easy option to enter and exit the market as per your monetary need. Unless you have opted for close-ended mutual funds, they are relatively easy to buy and exit in comparison to another individually invested scheme. Further, if you compare this to a fixed deposit where you cannot withdraw the amount without having to bear additional cost, the mutual fund seems a good option for those who may need quick liquidity options later on.
- Can invest in smaller denominations: You don’t have to have an outright large pool of funds if you want to invest in mutual funds. You can simply invest in the smaller denomination as little as Rs 500 in the form of Systematic Investment Planning (SIP). This way you can invest the amount into mutual fund periodically and see your investment grow with time.
- Competitive returns: The major objective behind the investment is to seek higher returns and see your wealth grow in the long term. Whether it’s a short term or a long term, mutual funds help to increase the possibility of getting higher returns (10 % to 13%) when compared to other means of investment like fixed deposit which only delivers (7% to 9%) in the long run, gold and real estate.
Disadvantages of Investing in Mutual Funds
Here are a few disadvantages of investing in mutual funds. Read along:
- Expense ratio: When you hire someone to help manage your funds and invest them in a way that they generate higher returns, you obviously need to pay for the services. That includes whether your mutual fund makes a profit or not. So whenever you opt for a mutual fund scheme you lose a certain amount as part of the management fees to the fund manager. That’s part of your expense ratio.
- Subject to Risk: Mutual funds do have the benefit of being one of the most profitable investment options in comparison to other investment options. But mutual funds are still subject to market risks and may end up fluctuating due to inherent risks. That may put a dent into your mutual fund outlay and may decrease the value of your investment capital.
- No control over the portfolio: In mutual fund investment, you appoint professional fund managers who make the decisions on your behalf. This may be an advantage when it comes to investing as professional fund managers are obviously knowledgeable and expert in the matter but at the same time, your right to make decisions gets lapsed as you can only review the performance of the experts and not directly partake in the day to day investment decisions. You may invest the amount in a mutual fund but you will have no control over your portfolio.
- Lock-in period: Mutual funds come in two forms as open-ended and close-ended mutual funds. Open-ended mutual funds allow you to enter and exit the market anytime while the close-ended mutual funds generally come with a long lock-in period ranging from 5 to 8 years. Out of the open-ended mutual fund, only ELSS has a lock-in period of 3 years which doesn’t allow you to withdraw funds before 3 years. As for other close-ended mutual funds, exiting from the mutual before lock-in period can be an expensive case. If you are to exit a mutual fund then you may subject to an exit charge also known as exit load which may affect your total returns.
- Over diversification: Although mutual funds are a great option for diversification, they also tend to be the cause for over-diversification. The phrase ‘blessings sometimes become a curse’ holds true in many cases. With mutual funds investment, you hold units of different stocks rather than owning individual stocks as a whole. This does reduce the risk of any impeding loss but also cuts back on the potential for gain. For example, an XYZ company has its shares trading at Rs 12000 per share. When you go for a mutual fund investment you may only hold some units of it. If the stock rises and becomes double its value, your portfolio will not rise by double but rather only the units of that stock will rise in double. So you may miss out on potential gains due to over-diversification.
Investing in mutual funds comes with its own set of advantages and disadvantages. But it doesn’t mean you should stay away from it. You can analyze your situation and determine your investment goals before delving into whether invest in mutual funds or not.