Investors who associate stocks to higher risk levels and plan to diversify their investment portfolio, often find themselves drawn to 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.
Benefits of Mutual Funds in India
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
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.
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
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.
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.
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.
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 that comes with an expense ratio of 0.06%.
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.
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 cost. 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.
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
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.
Frequently Asked Questions
Are long-term mutual fund investments more beneficial?
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.
Do all mutual funds have high risk?
The risk factor varies across mutual fund types. Typically, equity-oriented funds are riskier than debt-oriented ones.
Which mutual funds can be readily purchased or sold in the market?
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.
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