What Are The Advantages And Disadvantages Of Mutual Funds?

Mutual funds

One of the right way to put your money to use is to save and invest. There are many advantages and disadvantages of mutual funds. They help diversify investment portfolios with potentially generous short or long-term returns, can be managed by experts, you can decide if you want to invest in lump sum or in small amounts every month, etc. However, they also have limitations such as high expense ratio, exit load, etc. 

If you are new to investing in mutual funds, here’s a complete list of advantages and disadvantages of mutual funds. Keep reading!

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.

Types of Mutual Funds in India

Mutual funds are divided into multiple types based on their characteristics. To make an informed decision, it is important to know the different types of mutual funds present in the market: 

1. Equity schemes: Equity funds primarily invest in equity or equity-related instruments. They have the objective of long-term capital appreciation. Investors looking to invest for the long term and willing to take high risks can opt for these options.

2. Debt schemes: Debt funds allow you to invest in debt instruments like government bonds, corporate bonds and money market instruments. If you are looking to gain moderate returns while avoiding high risks, this will be your ideal option. Debt schemes tend to be less volatile than equity investments.

3. Hybrid schemes: Hybrid schemes are a mixture of equity and debt investments. Depending on your investment objective, you can opt for hybrid schemes. This particular type of mutual fund highly diversifies your portfolio.

You can choose equity-oriented hybrid funds if you are looking for high potential returns. In contrast, you can pick debt-oriented funds if you are risk-averse. 

4. Solution-oriented schemes: Under this mutual fund category, there are two funds- Retirement Fund and Children Fund. Both of these have a lock-in period of at least 5 years.

5. Other funds: include index funds, ETFs (exchange-traded funds) and FoFs (fund of 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.

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.

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

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

SIP or Lump Sum Investment – Which is Better?  

To understand which of the two investment options is better, you need to know what exactly the two processes entail. 

• SIP-  SIP or Systematic Investment Plan is the process that will allow you to invest a fixed amount regularly. If you are looking to invest in a more disciplined manner, SIP will be your go-to option. 
• Lump Sum- Lump sum Investment is depositing the entire available amount of money into a one-time investment. To opt for this method of investment, one must possess the required amount presently. 

To get a better grasp of the two investment processes, here is a chart drawing out the comparison between the two-

Comparison of Mutual Funds with Other Investment Products

The following table helps us understand the pros and cons of mutual funds compared to traditional investment products:

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 on Advantages and Disadvantages of Mutual Funds

Before you go…

Want to put your savings into action and kick-start your investment journey 💸 But don’t have time to do research? Invest now with Navi Nifty 50 Index Fund, sit back, and earn from the top 50 companies.

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.