Advantages and Disadvantages of Owning Mutual Funds

Many investors consider mutual funds to be one of the most popular investment vehicles. Adding a mutual fund to your investment portfolio is something you should consider seriously, regardless of your experience as an investor.

Mutual funds provide convenient diversification and professional management through a single investment, but can have high fees, tax inefficiency, and market risk like the underlying securities. However, you should be aware of the advantages as well as possible pitfalls of this investment.

Mutual funds: An overview

A type of investment fund called mutual funds enables investors to pool their money. The goal of the mutual fund is met by a professional fund manager who buys and sells securities accordingly. Instead of investing in numerous individual companies, investors have the option to simply buy shares in the mutual fund. All the hard work of choosing investments is done behind the scenes by the fund manager.

Many different types of mutual funds are available, depending on what you want to invest in and even how long you want to invest. For example, some funds invest in virtually the entire market or some section of the market such as a fund based on the S&P 500 index or Nifty 50 or a specific industry. If you need your money at a specific point in the future, such as retirement, a target-date fund can offer a solution that helps reduce your risk.

Most mutual funds charge an expense ratio, a fee that covers the fund’s operating expenses (administrative costs, marketing and salaries) and provides a profit for the fund managers. This fee is a percentage of the total assets you invested in the fund. In addition, some funds have what is called a sales load, which is a commission. Fortunately, many high-performing funds today do not charge a load, and it’s easier than ever to find them and avoid such funds needless fee.

Mutual funds have become a popular investment option due to their relative ease of investment and the availability of many companies offering them. Is it a good idea to invest in mutual funds? Let’s explore their advantages and disadvantages.

Advantages of Mutual Funds

Mutual funds are widely popular because of their convenience, professional management, and diversification. If you want to know how to choose the best mutual funds, make sure they meet all of these points.

Expert Management

Mutual funds are a good choice for investors who don’t have the time or skills to do the research and asset allocation. A fund manager takes care of everything and makes decisions on what to do with your investment.

The fund manager and the team of researchers decide on the appropriate securities such as equity, debt or a mix of both depending on the investment objectives of the fund. Moreover, the fund manager also decides on how long to hold the securities.

To choose a mutual fund, it’s important to consider your fund manager’s reputation and track record in fund management. SEBI mandates that the expense ratio cannot exceed 2.25% annualized of the daily net assets, which includes the fees of the fund manager.

Liquidity

Unless you choose close-ended mutual funds, buying and exiting a mutual fund scheme is relatively easy. Making a profit can be achieved by selling your open-ended equity mutual fund units when the stock market is high. Do keep an eye on the exit load and expense ratio of the mutual fund.

Diversification

Equity mutual funds have their share of risks as their performance is based on the movements of the stock market. Diversification is the term used by the fund manager to spread your investment across stocks of companies in different industries and sectors. In this way, when one asset class performs poorly, the other sectors can compensate to avoid losses for investors.

Less cost for bulk transactions

It’s likely that you’ve noticed a decrease in prices when you buy more volumes. For instance, if a 100ml coconut oil costs Rs 20, you might get a 500ml bottle for say, Rs 80.
Mutual fund units are also subject to the same logic. Buying multiple mutual fund units at a time will result in lower processing fees and commission charges than buying one mutual fund unit.

Invest in smaller denominations

Staggering your investments in mutual funds over time can be achieved by investing in smaller denominations of up to Rs 500 per SIP installment. By diversifying your investments across the lows and highs of the stock market, you can lower the average cost of investment. Regular (monthly or quarterly) investments, rather than lump-sum investments, enable you to benefit from rupee cost averaging.

Suits your financial goals

Investors across all walks of life can benefit from the many mutual funds available. Regardless of your income, it’s important to establish a habit of setting aside a small amount for investments. It’s not difficult to locate a mutual fund that matches your income, time horizon, investment goals, and risk preferences.

Cost-efficiency

Comparing the expense ratio of various mutual funds allows you to pick the one with the lowest expense ratio. The expense ratio is the fee you pay to manage your mutual fund.

Quick and hassle-free process

In order to build your portfolio, you can begin with a single mutual fund and gradually diversify across funds. Choosing from handpicked funds that are aligned with your investment objectives and risk tolerance is easier.

The tracking of mutual funds will be a hassle-free process. The fund manager and his team will determine when, where, and how to invest in securities based on investment objectives. In a nutshell, their task is to outdo the benchmark index and consistently produce the highest returns for investors.

Tax-efficiency

ELSS mutual funds are tax-saving, and you can take advantage of a tax deduction of up to Rs 1.5 lakh per annum under Section 80C of the Income Tax Act, 1961 by investing in them. Although Long-Term Capital Gains (LTCG) over Rs 1 lakh are taxed at 10%, they have consistently produced better returns than other tax-saving instruments in recent years.

Automated payments

Due to various reasons, it is common to postpone or delay SIPs. You can opt for paperless automation with your fund house or agent by submitting a SIP mandate, where you instruct your bank account to automatically deduct SIP amounts when it’s due. Staying on track with mutual fund investments is ensured by timely email and SMS notifications.

Safety

The general belief is that mutual funds are not as secure as bank products. It’s a myth that fund houses are not under the purview of statutory government bodies like SEBI and AMFI. Verifying the credentials of the fund house and asset manager through SEBI is a simple process. Their grievance redressal platform (SCORES) is impartial and works for the benefit of investors.

Systematic or one-time investment

Your mutual fund investment can be planned based on your budget and convenience. For instance, starting a SIP (Systematic Investment Plan) on a monthly or quarterly basis in an equity fund is suitable for investors with less money. If you have extra money, think about investing it in debt funds as a one-time lump sum.

Disadvantages of Mutual Funds

However, there are also disadvantages to being an investor in mutual funds. Here are some of those concerns.

Costs of managing the mutual fund

Investors pay for the salaries of market analysts and fund managers, as well as operational expenses for the fund. When choosing a mutual fund, it’s important to consider total fund management charges as one of the initial parameters. Better fund performance cannot be guaranteed by higher management fees.

Exit Load

Exit load is a fee charged by AMCs when exiting a mutual fund. For some time, investors are discouraged from redeeming their investments. This indirectly works like a lock-in period that fund houses use to maintain stability of funds. The fund manager can use it to obtain the necessary funds to buy the appropriate securities at the right price and time.

Dilution

Diversification can reduce your risk of loss, but it can also decrease your profits. Hence, you should not invest in many mutual funds at a time.

If you make informed choices, mutual funds’ benefits can undoubtedly outweigh their disadvantages, as above mentioned.

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