Advantages And Disadvantages Of Mutual Funds

Investors who associate stocks with higher risk levels and plan to diversify their investment portfolio, often find themselves drawn to the best mutual fund schemes.

And why not? Multiple benefits such as expert management, diversification and high returns, among others make it quite lucrative. However, mutual fund schemes also attract limitations such as high expense ratio and exit load, among others. 

Read along to find out about the major advantages and disadvantages of mutual funds below. 

What Are Mutual Funds?

A mutual fund comprises a large amount of money pooled in from several investors. Each mutual fund scheme has a dedicated fund manager responsible for analysing and investing in securities using the pooled wealth. These securities can be stocks, gold, and fixed-income securities such as bonds, commercial papers, and treasury bills.

Mutual funds are classified based on the types of securities they invest in. The most prominent ones are equity, debt, and hybrid funds. Equity funds invest in stocks primarily, and debt funds in fixed-income securities. But, hybrid funds invest in stocks and fixed-income securities in different proportions. 

Choosing one of these types is the investor’s call, depending on their investment objective. However, those who are still sceptical of choosing this investment option can look at the following benefits of mutual funds.

Also Read – What are the differences between a debt fund and an equity fund?

Advantages of Mutual Funds in India

1. Professional Fund Management

AMCs employ highly experienced fund managers to maintain mutual fund investments. They are responsible for choosing the investable securities and dividing the fund’s assets among those. For this, they conduct extensive market analysis and continuously monitor investments and adjust them to help individuals meet their financial goals.

2. Portfolio Diversification

This term describes the act of allocating wealth across various asset classes, so your investment portfolio is balanced. That’s why individuals willing to explore investments in various types of securities can opt for a mutual fund scheme. They can also choose a fund type depending on their risk appetite. For instance, equity mutual funds invest at least 65% of the wealth in company shares and the rest in other assets. 

3. Risk Mitigation

Investing in individual equity shares is highly risky. Diversification adds to the primary advantages of investing in mutual funds by investing in different industrial sectors. It effectively reduces the risk of losing out on your entire investment because it’s unlikely that different sectors will perform poorly all at once.

Also read: What is diversified equity fund: Benefits & how to invest

4. Significant Returns

Return on Investment (ROI) is the income that an investment generates. Mutual funds, in general, offer higher returns than pure fixed-income options such as fixed deposits and bonds but relatively lower returns than equity shares. However, before considering the advantages and disadvantages of mutual funds, individuals need to examine their financial goals and the period within which they want to achieve them.  

5. Convenient Investment Plans

Whether you are a pro or someone who has just started with mutual fund investments, there is a suitable investment method for everyone. Salaried individuals can start with periodical instalments of as low as Rs. 500 via SIP. Conversely, individuals willing to deposit a significantly large amount can opt for a one-time investment via a lump sum. Minimum investment starts from Rs. 1000 in that case.

6. High Safety

Individuals unsure of the safety of their investments need not worry about it. The Association of Mutual Funds in India (AMFI) and the Securities and Exchange Board of India (SEBI) work jointly to safeguard the interest of mutual fund investors. They monitor and manage investments, fund house policies, and fund managers to ensure high safety.

Disadvantages of Mutual Funds in India 

Individuals must also keep in mind the limitations of mutual funds before proceeding with an investment.

1. High Cost

Asset Management Companies 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. However, individuals can avoid paying these high costs by opting for passive funds such as the Navi Nifty 50 index fund which comes with an expense ratio of 0.06%.

2. Fluctuating Returns

Although mutual funds offer the potential for high profits, they do not guarantee fixed gains. 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. However, such a cost does not apply to every mutual fund. For example, the Navi Nifty 50 Index Fund does not levy any entry or exit load for investing in the fund scheme.

Now that you are aware of the advantages and disadvantages of mutual funds, it is time to compare their features against those of competing investment products.

Also read: What is a consolidated account statement: Benefits, limitations & steps to generate

Comparison of Mutual Funds with Other Investment Products

Look at the following table to understand the pros and cons of mutual funds compared to traditional investment products.

Parameters	Mutual Funds	Fixed Deposits	Bank Deposits	Bonds and Debentures	Direct Equity	Public Provident fund	Gold
Returns	High and diversified but fluctuating	Constant but low	Constant but low	Regular but moderate	High but non-diversified	Steady but moderate	Fluctuating but high
Liquidity	Investors can sell and repurchase open-ended funds anytime	Investors cannot exit fixed deposits before it matures	Individuals can withdraw from regular deposits after paying a penalty	Only available after trading in the market or on maturity	Ready liquidity with the continuous sale and purchase options	Unavailable before tenure completion	Difficult for physical gold
Lock-in period	None for open-ended, 3 years for close-ended	5 years	1-10 years	5-10 years	None	15 years	It depends on the type of  investment
Costs	Entry load, expense ratio, and exit load	Negligible to none	Cash withdrawal and cash deposit charges	Demat account charges	Brokerage and Demat charges	None	Making charges
Risks	Market risk and inflation	Default risk, i.e., when the issuing bank fails to pay the fixed deposit)	Default and trading risks	Interest rate and credit risk	Volatile price movements	None	Theft or loss and price movements

Final Word

Mutual funds have advantages and disadvantages, hence, substantial 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. 

Also read: What is a zero brokerage DEMAT account

Frequently Asked Questions

Before you go… 

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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.