Advantages & Disadvantages of Mutual Funds Investment

You might have seen the Mutual Funds advertisement on television where, you hear about mutual funds helping their investors achieve their dreams. Should you choose mutual funds for your investments, is something that you should decide for yourself. Let’s discuss why you can consider mutual funds as an investment option to fulfil your dreams.

What are mutual funds?

Mutual funds are investments made in a basket of securities (equities, bonds, currencies and treasuries, etc.), for pre-determined objectives (goals like buying a house, building wealth and retirement corpus, etc.), keeping in mind the associated risks, returns and time period.

These funds are professionally managed by fund managers. Here, investors entrust fund managers with a basket of funds, which are then invested in securities. The generated returns are then passed on to the investors.

Why should you invest in mutual funds?

• Managed by Professionals: 

  Mutual funds are managed by experienced fund managers, with expertise and robust research experience in market dynamics. These professionals are appointed out by the Asset Management Company (AMC) who carry out the required research for diverse investment opportunities, monitor the markets and decide whether to invest in equity or other financial asset class. They dedicate their career in assisting investors to receive the best risk-return trade-off in accordance with their financial objectives. Their market expertise can help you get handsome returns on your investments.

• Affordability:

  Unlike direct equity investments, mutual funds are easy to understand and invest. You can start your Systematic Investment Plan (SIP) with an amount as minimal as Rs.500 per month. This will allow you to get exposure to the entire stock or other asset-class without increasing transactional expenses. For as little as Rs. 500 per month you can own the shares of blue-chip stocks and host other expensive securities via mutual funds.

• Convenient:

  Online investment platforms, all in one account and many other digital features have made the investment process seamless. Having one account for all mutual funds makes investment tracking easier. You can now refer to digital features where you can compare various funds available. Some features also recommend the right mutual fund to suit your goals.

• Better returns than gold or fixed deposits (FD): 

  Investing in a mutual fund that is well-diversified across multiple asset class has a better chance to provide higher returns than other investment options like gold, Fixed Deposits (FDs), and real-estate. This has proven over the years that mutual funds give more returns than gold or FD over a period of time.

The SENSEX was introduced in 1986. Assume that you had invested Rs.1000 each, in Gold, Fixed Deposits, and in an index mutual fund (a type of mutual fund that tracks SENSEX or Nifty), 32 years ago. In July and August 2018, your approximate investment value would be as follows:

• In 1986, with Rs.1000, you would be able to purchase approximately 5 grams of gold. Therefore, the present values are calculated on the basis of the current value of 5 grams of gold.
• Value of fixed deposits and Index Mutual fund was calculated using the compounding calculator. For fixed deposits, the average interest rates for 5+ year deposits in 1986 was taken and its compound interest was calculated till the year 2018.
• For index mutual funds, the compound interest was calculated based on the percentage change in the SENSEX from 1986 to July 2018 and August 2018.
• Gold rates were referred from: https://www.bankbazaar.com/gold-rate/gold-rate-trend-in-india.html?ck=Y%2BziX71XnZjIM9ZwEflsyDYlRL7gaN4W0xhuJSr9Iq7aMYwRm2IPACTQB2XBBtGG&rc=1
• Fixed Deposit Rates referred from: https://rbi.org.in/scripts/PublicationsView.aspx?id=12765

In terms of percentage, the 32 years approximate average annual return is as follows: 

• Tax Benefits: 

  Mutual funds not only help you in building wealth but also provide tax benefits. In ELSS mutual funds, returns on the invested amount are higher than that in other tax saving instruments like PPFs, FDs and NSCs. This tax-saving fund provides the dual benefit of tax saving and capital appreciation through investing in equity or equity-related securities. The Investments made under ELSS mutual funds are eligible for tax exemption of up to Rs. 1,50,000 under Section 80C of the Income Tax Act, 1961. Let’s compare the current interest/return rates of all these tax saving instruments. On your investments, Public Provident Fund (PPF) and National Savings Certificate (NSC) provide interest of 7.60%. FDs provide an interest of 6.25% on your investments. However, an investment in Equity Linked Savings Scheme (ELSS), a type of diversified equity mutual fund provides a return of 18.24% according to the current rates.

• Diversification: 

  Since one of the primary rules of investing is to diversify portfolios to minimize the risks, a mutual fund portfolio made of a variety of stocks, bonds, commodities, and other asset-classes comes with built-in diversification. Here, you can diversify your portfolio by investing in a basket of securities like equities, bonds and commodities etc. This helps you get the best of each of these securities while managing their risks. Even if some stocks in your basket are not performing well, other outperforming securities can make-up for them.

Disadvantages of mutual funds?

• High Expense Ratio:

  If you’re hiring someone to manage your investments on your behalf and generate high returns for you, obviously you need to pay for services. That includes whether you make profits out of it or not. The charges you pay annually to the company to manage your mutual fund portfolio is called expense ratio. For instance, if you’ve invested Rs. 50,000 in a mutual fund which has an expense ratio of 2 per cent, then it means you need to pay Rs. 1000 to manage your money. Simply put, if your fund earns returns equal to 10 per cent and has an expense ratio of 2 per cent then you would earn a return of 8 per cent. High expense ratio could impact your overall returns. So, be cautious of expense ratio when investing in mutual funds.

• Lock-In Period:

  Some mutual fund investment schemes have lock-in periods especially, close-ended funds which deny investors the liquidity, which they believe is crucial. Many mutual funds have lock-in periods, ranging five to eight years. With this on, if you decide to take the money out earlier, you’ll get charged for exiting prior maturity.

• Over-Diversification:

  Although mutual funds come with built-in diversification, there are many pitfalls of over-diversification. The thing with diversification is to average your losses. With diversifying your investment portfolio across multiple asset-class or MF schemes, the risks will be reduced though, but so will the potential for making big profits. It is recommendable to not invest in too many mutual funds at a time. Mutual fund itself a diversifying investment therefore, investing in multiple mutual funds in the name of diversification leads to dilution in gains.

No matter what your goals are, mutual funds always have something to offer. reliancesmartmoney.com is the one-stop shop for all your investment needs; where you can pick the right mutual fund for you. Thus, if you are looking for convenient, economical, professionally managed, quick building and diversified investment solutions, mutual funds are the right funds for you. Start investing in mutual funds now to realize your goals and achieve financial security.