What are the Advantages and Disadvantages of Mutual Funds – Calculate your Returns
Planning to invest in mutual funds just because your friend told you to? Of course, mutual fund investments have a lot of potential, but there’s more to it than meets the eye. In this blog, we have detailed out the advantages and disadvantages of mutual fund investments so that you can understand the potential risks and benefits, and make an informed investment decision. Let’s dive in.
Advantages of Mutual Funds
Here are some of the advantages of mutual funds:
1. Potential to Generate Higher Returns
Mutual funds, in general, offer higher returns than pure fixed-income options such as fixed deposits and bonds. Investing in mutual funds could help investors generate inflation-beating returns.
2. Diversification
Mutual funds allow investors to diversify their portfolio by investing in a basket of stocks and securities. This helps in spreading out risk and potentially reduces volatility in the portfolio.
3. Professional Management
Mutual funds are managed by professional fund managers who have the expertise and resources to conduct in-depth research and make informed investment decisions.
4. Affordability
Mutual funds are accessible to a wide range of investors, as they can be purchased with relatively small amounts of money. You can invest with just Rs.10 with fund houses like Navi Mutual Fund.
5. Tax Benefits
For ELSS (Equity-Linked Savings Scheme) investments, you can claim tax benefits up to Rs.1.5 lakh under Section 80C of the income tax act.
6. Convenience
Mutual funds provide a convenient way for investors to save for long-term goals, such as retirement, as they can be set up to automatically invest a set amount on a regular basis.
7. Liquidity Options
As an investor, you can easily liquidate or redeem units of open-ended mutual funds on any business day to fulfil your financial requirements. After redemption, the amount will be directly credited to your bank account within 3-4 working days.
Please note that the time taken to credit the amount to your account will depend on the type of scheme.
8. Suitable for Every Financial Goal
Each mutual fund scheme has a specific investment objective. This leaves you with a lot of investment options based on your investment horizon, financial goals and risk appetite.
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Disadvantages of Mutual Funds
Individuals must also keep in mind the limitations of mutual funds before proceeding with an investment.
1. High Cost of Managing Funds
Asset Management Companies (AMCs) charge an annual fee for effective portfolio management. This is called the expense ratio and can vary across fund schemes. Mutual funds, particularly actively managed ones, come with high expense ratios since they require the continuous efforts of a fund manager to be profitable.
2. Fluctuating Returns
Although mutual funds have the potential to offer higher returns, they do not guarantee profits. Investment units are subject to market risks, and their values keep changing depending on various factors.
3. Exit Load
Several fund houses charge an additional cost when investors sell units before a specific period. This is called exit load, and it adds to the burden of investment costs.
4. Diversification and Dilution
It is true that diversification mitigates the risks present in a scheme, but over-diversification can lead to dilution which is a disadvantage. For example, if a particular security in a scheme doubles in value, the value of the overall fund would not improve as the security constitutes only a small part of it.
5. Dependence on Fund Manager
For actively managed funds, the performance of the fund is heavily dependent on the skill of the fund manager. A fund manager with mediocre skills could be detrimental for investors.
Calculate Returns on Mutual Funds
Calculating mutual fund returns helps investors have a clear idea about the amount he/she will earn as returns. The formula for calculating lump sum mutual fund returns manually is given below:
M = P (1 + r/100)^n
Where, M = amount you will receive at maturity,
- P = principal amount you have invested,
- r = estimated rate of return you earn on your investment, and
- n = holding period in years
However, there is no need to spend a lot of time using such complicated formulas to compare mutual funds. Instead, you can use an online returns calculator to avoid errors and get accurate results within seconds.
Total Investment
Expected return rate (p.a)
%
Time Period (Years)
Invested Amount
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Est. Returns
Total Value
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Final Word
It is advisable to read all the documents and check out the advantages and disadvantages of mutual funds. Returns, expert advice, availability of convenient investment schemes, and the scope to spread out the risk of investment are among the top advantages that could work in your favour. However, you should also keep in mind drawbacks such as fluctuating returns, investment cost, and exit load before investing in mutual fund schemes.
FAQs
Ans: Yes, most financial experts advise opting for long-term investments, especially if you are opting for an equity mutual fund scheme. This is because share prices move up and down dramatically in the short run but offer more balanced and high profits in the long term.
Ans: The risk factor varies across mutual fund types. Typically, equity-oriented funds are riskier than debt-oriented ones.
Ans: Liquid mutual funds can be readily bought and sold in the investment market mainly because of the low levels of interest risks associated with them. Such funds invest mostly in fixed income securities with high credit ratings and a short maturity period. Collectively, these traits make them a lucrative investment instrument.
Ans: Some of the important advantages of mutual funds include portfolio diversification, risk mitigation, minimal investment amount via SIPs, high liquidity, accessibility and affordability. Investing in ELSS also involves tax benefits.
Ans: A few disadvantages of mutual fund investments include high costs of fund management, fluctuating returns, strict lock-in periods, exit loads, diversification and dilution.
Ans: Based on organisational structure, mutual funds can be open-ended, close-ended or interval. The management style of a fund’s portfolio also divided mutual funds into two types- actively managed and passively managed funds or index funds. Based on the underlying portfolio, mutual funds can again be classified as equity funds, debt funds and hybrid funds.
Ans: Mutual fund performance depends on the market. So, if you understand the market well, and invest strategically and diligently, you can mitigate the risks. That being said, stay invested for a longer period of time to realise the actual potential of mutual funds.
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
