Today, mutual funds are the most popular investment choice for individual investors since they provide an indirect but safer method to participate in the stock market!
A mutual fund is something you should carefully consider adding to your investing portfolio, whether you are a seasoned or first-time investor.
Mutual funds are ideal for newcomers. However, you should not invest in mutual funds blindly. Before investing your hard-earned money in mutual funds, you should be aware of the mutual funds advantages and disadvantages.
There are multiple ways you can buy mutual funds. The most popular and profitable way is to buy mutual funds without a broker.
Table of Contents
What are mutual funds?
A mutual fund is a professionally managed investment vehicle that pools the money of many investors and invests it in stocks, bonds, and other assets. It is often administered by an asset management firm.
Investing in mutual funds allows individuals with a little amount of money to reap the same benefits as big institutional investors.
An investing expert known as a fund manager or portfolio manager oversees this collection of funds. It is his/her responsibility to invest the corpus in various securities such as bonds, stocks, gold, and other assets in order to maximise prospective returns.
The investment profits (or losses) are shared jointly by the investors in proportion to their commitment to the fund.
Mutual Funds Advantages and Disadvantages
As much as tempting it may sound to you, let’s have a look at the mutual funds advantages and disadvantages:
Mutual Funds Advantages
There are many reasons why individuals choose to invest in mutual funds on a regular basis. Let’s go into the specifics of a few.
- Portfolio Management at its Finest
When you purchase a mutual fund, you pay a management fee as part of your cost ratio, which is used to employ a professional portfolio manager who buys and sells stocks, bonds, and other investments. This is a modest fee to pay for expert assistance in managing an investing portfolio.
- Reinvesting Dividends
When dividends and other interest income sources for the fund are announced, they may be utilised to buy more shares in the mutual fund, allowing your investment to expand.
- Risk Mitigation (Safety)
Diversification reduces portfolio risk since most mutual funds invest in anywhere from 50 to 200 different assets, depending on the emphasis. Many stock index mutual funds have 1,000 or more individual stock holdings.
- Convenience and Reasonable Pricing
Mutual funds are simple to purchase and comprehend. They usually have minimal minimum investment requirements and are only exchanged once each day at the closing net asset value (NAV). This removes price fluctuations throughout the day as well as the numerous arbitrage possibilities that day traders take advantage of.
- Increased Diversification
When you invest in mutual funds, you get instant access to a far broader selection of companies that provide more diversity than an individual investor’s portfolio.
Mutual funds assist investors in diversifying their risk-bearing by dispersing their exposure to a particular investment or group of assets.
- Professional Management and Supervision
Mutual funds are professionally managed by fund managers with extensive expertise in the financial markets. The portfolios are managed by the fund managers, who work with a team of subject matter experts to choose assets and create strategies to maximise returns for the scheme’s participants.
- Investments that are adaptable
Mutual funds, such as SIPs, may be established with as little as Rs.500. You may continue to raise the amount invested as your earnings rise. However, if you wish to profit from the mutual fund’s long-term success, you should consider making bigger investments.
- Tax Advantages
Tax exemption/deduction is also available with multiple mutual fund investments. Investments in Equity Linked Savings Schemes (ELSS), for example, are eligible for tax deductions of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. Furthermore, investing in equity mutual funds may result in tax-free profits in the form of zero long-term capital gains.
- Greater Liquidity
Mutual funds are regarded as one of the most liquid investing choices. Specifically for investors who invest in debt funds, since they have no entry and exit loads and can be quickly redeemed. Furthermore, certain fund companies provide advantages such as quick redemption and debit card withdrawal of your mutual fund investment in the event of an emergency.
Mutual Funds Disadvantages
There are certain drawbacks to investing in mutual funds. Here’s a closer look at some of those issues.
- Sales Charges and High Expense Ratios
Mutual fund cost ratios and sales charges may quickly get out of hand if you’re not paying attention. When investing in funds with expense ratios more than 1.50 percent, use extreme caution since these funds are regarded to be on the upper end of the cost spectrum.
- Inefficiency in taxation
Whether they like it or not, investors have no option when it comes to capital gains payments in mutual funds. Investors usually get distributions from the fund that are an uncontrolled tax event due to the turnover, redemptions, gains, and losses in securities holdings during the year.
- Ineffective Trade Execution
If you make your mutual fund transaction before the same-day NAV cut-off time, you will get the same closing price NAV for your buy or sell on the mutual fund.
Mutual funds are a poor execution method for investors seeking quicker execution timeframes, whether due to short investment horizons, day trading, or market timing.
- Period of lock-in
Some mutual fund investments, such as ELSS, have a three-year lock-in term, which means you won’t be able to redeem the amount invested before the stipulated time period. In contrast, you are required to remain invested in other funds for a year. If you decide to leave a fund before the lock-in period is up, you will have to pay an Exit Load.
- Excessive variety
Diversification offers numerous advantages, but it also has many disadvantages. Diversification reduces an investor’s risk of loss, but it may also dilute gains if done excessively. The quantity of securities you own is proportionate to the impact of individual results on your portfolio.
As a result, it is recommended that you do not add too many funds to your portfolio at one time, so that the beneficial impact of each fund is clearly apparent in terms of higher returns.
- Returns that fluctuate
Mutual funds are vulnerable to market volatility. The market’s patterns may change from time to time, therefore mutual funds cannot provide set returns. Furthermore, the value of mutual fund assets may fluctuate over time. Such market fluctuations may be handled by fund managers who keep a close eye on shifting market patterns.
- Abandonment of control
Investors cannot have complete and direct control over where their money is placed. They can only passively monitor the scheme’s portfolio.
Although each fund is open about the percentage of their asset allocation (say, 30% debt and 70% equity) and publishes information about the individual assets in the portfolio, dividend payment, expense ratios, and so on, an investor can only have so much control. The investor has no direct influence on the management of the funds.
The fund manager charges a high fee for competent management of the fund’s portfolio. A mutual fund trust incurs many additional expenditures, such as huge advertising costs, distributor’s commission, administrative charges, and so on. All of these expenses are subtracted from the fund’s net assets and contribute to the fund’s NAV.
Why mutual funds are the best investment?
Mutual funds provide an excellent method for investors to quickly diversify their assets. In contrast to equities, investors may deposit a modest amount of money into one or more funds and get access to a broad pool of investment choices. As a result, you may purchase units in a mutual fund that invests in up to 30 different assets.
If you were searching for the same thing in the stock market, you would have to spend much more money to get the same outcomes.
Mutual funds also invest in a wide range of industries. As a result, a big cap fund may invest in a variety of sectors, including finance, technology, health care, and materials. Again, if you tried to duplicate this with individual stocks, you’d have to spend a lot of money to achieve the same results.
The ease of use of mutual funds is undoubtedly one of the primary reasons investors choose them to supply the equity component of their portfolio rather than purchasing individual shares.
Some investors find it simpler to purchase a few shares of a mutual fund that satisfies their basic investing requirements than to learn about the businesses in which the fund invests and if they are high quality investments.
Individual investors expenses of frequent stock transactions may rapidly mount up. Gains from stock price growth may be offset by the expenses of selling all of an investor’s shares of a particular business in a single transaction.
However, with a mutual fund, the cost of trading is shared among all fund participants, reducing the cost per person. Many full-service brokerage companies profit from these trading expenses, and their brokers are motivated to trade their customers shares on a frequent basis.
Though a broker’s assistance may help customers make smart investment choices, many investors discover that the financial advantage of hiring a broker just does not outweigh the expenses.
- No one will steal your money.
If you are concerned that mutual funds are a kind of faulty investment, you may rest assured that mutual funds are entirely secure. You will not wake up one day to discover that the mutual fund in which you have invested has disappeared along with your money.
No fund company may steal an investor’s money since mutual fund firms are controlled and monitored by regulatory bodies such as the Securities and Exchange Board of India (SEBI) and the Association of Mutual Funds in India (AMFI).
- Mutual funds are designed to provide greater, tax-efficient returns.
Over longer time periods, mutual funds have provided better returns that have outperformed conventional investments while also outperforming the current rate of inflation.
Mutual funds also have less taxes than other types of investing. Furthermore, the combination of inflation-beating returns and tax-efficient returns makes mutual funds an attractive investment option for seasoned investors.
Why mutual funds are subject to market risk?
Mutual funds, like other assets, are susceptible to market risk, also known as systematic risk. This is because there is no way to anticipate what will happen in the future or whether the value of a particular item will rise or fall. No investment is risk-free since the market cannot be precisely anticipated or fully controlled.
- Market risks and their classification
Market risks and company-specific risks are the two main types of hazards. Market risks are those that impact the whole market as a whole. These are also called as systemic hazards since they impact the whole system.
- Instability in politics
Political unrest is a major risk for any market. If the Central Government is not stable, the markets suffer. Some years under the UPA II administration (2009-2014), economic policy was paralysed. Stagnant reforms resulted in a slowing of GDP growth and a drop in market prices.
As a result, the government’s stability, reform programme, and drive are critical for the market to perform well or remain steady.
- Interest rate volatility
Markets do not benefit from high interest rates. In a low-interest-rate environment, stock markets often do well. Companies may borrow at cheaper interest rates and invest in company growth, which leads to increased earnings.
- Risk of inflation
In India from 2010 to 2013, there was a period of significant inflation. Rising inflation in 2011 was caused by higher crude oil prices, which had surpassed USD 100/barrel. As a result, the RBI was forced to raise interest rates, causing the Sensex to fall by approximately 25% in 2011. When inflation is moderate, stock markets often do well.
- Currency volatility
A currency that depreciates too quickly poses a danger to the markets since it may cause investor fear and, as a result, a sell-off in the entire market. In 1997, the currencies of several Asian countries, precipitating the Asian Financial Crisis, which culminated in a massive sell-off in stock markets.
- Exodus of foreign funds
Foreign money inflows are critical to India’s and many other countries capital markets. Any reversal of foreign money flows out of these economies poses a significant danger to capital markets and may result in a significant market correction.
SEBI placed limitations on capital market investments via participation notes utilised by Foreign Institutional Investors in 2007. This resulted in a large sell-off of Indian stocks by FIIs, causing the Sensex and Nifty to reach a lower circuit breaker.
- Commodity price increases
Commodity price increases, such as those seen in crude oil, gold, copper, and aluminium, pose a significant danger to individual and corporate consumers. The majority of these goods are imported into India.
High import costs, particularly for crude oil and gold, exert pressure on India’s current account deficit, fiscal deficit, foreign debt, and so on, disrupting the country’s balance of payments.
This has a detrimental impact on stock markets. Most commodity prices hit all-time highs in 2008, resulting in high inflation and interest rates. All of this ultimately contributed to the collapse of financial markets.
- Default danger
Debt mutual funds are vulnerable to the risk of the borrower business failing to repay the money borrowed against the issuance of debt security. Debt schemes that invested in IL&FS securities in 2018 and DHFL securities in 2019 suffered losses as a result of these businesses’ failure to repay.
- Reinvestment risk
Debt mutual fund schemes bear the risk of interest rate declines. If interest rates decrease from, say, 8% to 6% over time, assets purchased at 8% must be reinvested at 6%.
- Risk of liquidity
Liquidity risk occurs when a mutual fund scheme is unable to find a buyer for any of its portfolio assets or finds a buyer at a price lower than the market/fair value. If any of the portfolio securities become illiquid, the scheme may be forced to incur a loss in order to sell them, resulting in losses for its investors.
Final Words !
When investing, you should be aware of the benefits of mutual funds. Once you understand that, you must learn about its drawbacks. Only by weighing the mutual funds advantages and disadvantages you can choose the best funds for you.