Investing your hard-earned money wisely is a great way to grow your wealth over time. Mutual fund investments can be great option to achieve this goal.
Mutual funds are an investment vehicle to invest in financial markets with an objective of earning better returns on investments.
Knowing the mutual funds advantages and disadvantages shall help you decide whether you should invest in mutual funds or not.
What is A Mutual Fund
A mutual fund is a type of investment consisting of a pool of funds from many different investors that are managed by a professional financial manager.
The manager invests the combined money into various stocks, bonds, and other securities in an effort to achieve the goals of the particular fund scheme. Mutual funds offer diversification as well as certain tax benefits making them an attractive option for many investors.
Mutual Funds Advantages
Read on to know what are the advantages of mutual funds which make them a better investment option!
Mutual funds offer you the flexibility to control how your money is invested. You can choose from actively managed funds or passively managed index-tracking funds.
Actively managed fund schemes are managed by fund managers. They take appropriate action at appropriate time with respect to the portfolio of the stocks when some of the stocks are not performing as expected. These funds have higher cost and the potential for higher returns than passive funds.
Passively managed funds do not have active role of fund managers. Default stocks of a market index in default proportion as their weightage in the index are taken to build a portfolio. The returns of these funds are in line with the index they follow. These fund scheme have low cost.
Another advantage of investing in mutual funds is that you benefit from the expertise and knowledge of professional fund managers.
These professionals continually monitor markets, conduct research, analyse data, and make decisions on which stocks or bonds to buy or sell based on their assessment of risk/return profiles.
This means that you don’t have to manage your investments yourself, saving time, effort and cost when compared with other forms of investing.
With mutual funds you don’t have to spread your money across multiple stocks or securities to build a diverse portfolio; all you need is one mutual fund scheme. Each scheme has its own portfolio consisting of different stocks providing the benefit of diversification.
Diversification reduces the risk to your investment. If any stock or sector in the portfolio underperforms, it gets compensated by other performing stocks or sectors. Thus, diversification helps in averaging the performance of the portfolio and yielding better returns on investments.
The liquidity provided by mutual funds makes them a great option for short-term as well as long-term investment strategies. This is particularly helpful to you at the time of a financial emergency.
Except for tax saver funds with lock-in period and close-ended mutual fund schemes, mutual funds are one of the most liquid investments. You can sell your investment and exit the mutual fund scheme anytime. This is in contrast to real estate which are very illiquid investments.
Investing in mutual funds requires only minimal effort, especially when compared to trading stock markets. Stock trading requires much more time, effort and skills to make money.
With mutual fund investing, all this hard work is done by the professional fund managers. Your job is just to choose an appropriate mutual fund scheme as per your financial goal.
This leaves you with more time available for other personal interests such as spending quality time with family and friends or pursuing leisure pursuits like sports and hobbies outside work related commitments etcetera – thereby increasing overall satisfaction levels derived from life experience overall rather than simply fussing over indices and markets movements thereafter!
Low Risk Options
Many lower risk options exist within various types of mutual funds. Some conservative investments such as Money Market funds generally offer decent returns without taking high risks; Balanced Funds which typically include a mixture of stocks and fixed income assets so as provide both growth potential together with some income stability too.
Investing in mutual funds carries nominal fee to the investors. Asset management companies or AMCs charge this fee to manage the investment and pay transaction charges.
This fee/cost is considerably small when compared to brokerage charges directly paid in case of direct stock investing or trading.
Earlier, there used to be entry load to buy a mutual fund scheme which has been abolished now. Now, only exit load is payable when you sell your investment before a specific time period.
Mutual funds allow you to participate in the growth of the economy. As the economy grows, so does the market.
By participating in the growth of the market, you’ll earn higher returns on your investments.
Mutual funds have the potential to generate higher rate of returns as compared to traditional savings scheme.
If you want to invest your money for long time (5-10 years), it is better to opt for mutual fund investments than fixed deposits (FDs) or recurring deposits (RDs).
These funds may offer returns more than 12% while FDs or RDs yield only 5-6%.
You get mutual funds tax benefits under section 80C of the Income Tax Act when investing through equity linked savings scheme (ELSS). The amount invested is exempted for tax calculation.
In addition to that there is deferred tax advantage which means you are liable to pay tax on the returns only when you exit the mutual fund scheme. This helps in wealth creation along with tax savings in the long run.
Investing in mutual funds is highly transparent process. It is well regulated by the securities regulator SEBI or Securities and Exchange Board in India.
Investor’s interests are taken care of at every step so as to establish trust.
You can invest in a mutual fund scheme as per your needs or goals.
For short term savings along with better returns, there are liquid funds. For wealth creation, you can invest in equity based mutual funds. For tax savings along with capital appreciation, there are tax saver mutual funds allowing lumpsum investment or in installments through equity linked savings scheme or ELSS.
Mutual Funds Risks
Although, there are so many advantages of investing in mutual funds, they are not without risks.
Mutual funds always come with a warning;
“Mutual fund investments are subject to market risks. Please read offer document carefully before investing”
Thus, it is very important you totally understand what you are going to do.
Mutual fund investments are done as per their net asset value or NAV. The net asset value of a mutual fund scheme keeps fluctuating as per the performance of the stock market or money market securities.
The returns of a mutual fund scheme are never guaranteed. It may even generate negative returns on the investment made. This makes mutual fund investments risky.
However, diversification in the portfolio of mutual fund scheme can manage that risk considerably. As this portfolio is managed by market professional fund managers who take appropriate decisions at appropriate time to get best returns, hence mutual funds have the potential to generate better returns in the long run.
Risk Management and Diversification Benefits
Investing in mutual funds offers the potential of both diversification and risk management.
With a pool of stocks and other investments, each held at only a small proportion of the fund’s portfolio, investors are exposed to fewer risks through mutual funds than if they had invested in just one or two assets.
Diversification leads to smoother returns over time, and potentially reduced losses during periods of market volatility.
Additionally, mutual funds have professional managers that actively monitor their holdings, ensuring that investors have a long-term strategy for achieving their desired return goals.