October 13, 2023

Advantages and Disadvantages of mutual funds

Advantages and Disadvantages of Mutual Funds

The advantages of investing in mutual funds are portfolio diversification, lower expenses, high liquidity, professional management, etc., and the disadvantages of investing in mutual funds are costs for professional management, fund manager bias, etc. 

Let’s explore more about 

Advantages of Mutual Funds

One of the major advantages of mutual funds is portfolio diversification, mutual funds invest in diversified financial instruments, such as stocks, bonds, money market securities, government securities, etc. Therefore, it reduces the overall risk of your portfolio by spreading your investment across different asset classes. 

Here is the list of advantages of mutual funds: 

Lower Expenses

Every AMC charges some percentage of the expense ratio, which includes the annual charges and other maintenance charges. This cost gets distributed to the number of investors investing in that scheme, so a single investor has to incur a lower cost.

Highly Liquid

Mutual funds are highly liquid, as you can sell the units at any time on working days at the prevailing NAV (net asset value), which is declared every day by the AMC at the end of the day. If it is a closed-ended scheme, you can redeem your investments anytime by paying a specified percentage of the exit load.

Professionally Managed

You may not have the time to monitor the market and analyze the individual stocks, but mutual funds are managed by a fund manager who will keep an eye on how the stocks are performing. He will do the portfolio rebalancing from time to time according to the SID and try his level best to remove the instruments that are not giving the required return.

Invest With a SIP

You can invest in a mutual fund through a SIP (Systematic Investment Plan), not just with a lump sum. The SIP allows you to invest with a regular installment as low as ₹500, where the installment can be paid weekly, monthly, or quarterly.

Automated Investments 

The SIP method allows the investor to give a mandate to a bank, wherein they automatically deduct the amount from your bank account, and the units of a mutual fund account accumulate in your demat account. Hence, you need to worry about seeing if the investment is being made or not.

Easy Availability 

Mutual funds are easily available to invest any time from anywhere in the world through your demat account or mutual fund account. Every AMC distributes the scheme by themselves and through various channels such as brokerage firms, registrars like Karvy and CAMS, etc. You can invest in them with just one click from your smartphone and keep track of all of your investments in one place.

Suitable For Every Type Of Investor

There are different types of mutual fund schemes that can suit every investor’s investment profile. Equity funds are best for earning an inflation-beating return with a high level of risk. Debt funds are best for earning stable returns with low risk. Hybrid funds are best for balancing risk and return. Therefore, each investor can find a mutual fund that best matches their financial goals.

Regulated By SEBI

Mutual funds are regulated by the SEBI (Securities and Exchange Board of India) under the SEBI (Mutual Funds) Regulations, 1996. This act has the rules, policies, and regulations of the mutual funds to protect the investor’s interests at the best level.

Comes With a Riskometer Label

The riskometer is a meter-type graphical representation that depicts the principal at different levels of risk, such as low, low to moderate risk, moderate, moderately high, high, and very high.

A risk-o-meter label is attached to every mutual fund document, and they are always updated on a monthly basis, which you can see and use to make your decision. 

ELSS: A Tax-saving Scheme 

ELSS (Equity Linked Savings Scheme), which is a type of equity mutual fund scheme, can help you save on taxes on the investment amount of ₹1.5 lakhs every financial year under Section 80C of the Income Tax Act, 1961. One thing you need to know is that the ELSS fund has a lock-in period of 3 years, which means you can not withdraw your funds before 3 years. 

Flexibility 

Mutual funds provide the much-needed flexibility to redeem the investment anytime and have the lowest lock-in period, such as ELSS funds, which have a lock-in period of just three years as compared to any traditional tax saving scheme such as PPF.

Tax Advantages

Investors falling into higher tax brackets will benefit from investing in mutual funds because each type of mutual fund’s short-term capital gains (STCG) and long-term capital gains (LTCG) are taxed according to some predefined percentage and not on the basis of the tax brackets they are falling into.

Disadvantages of Mutual Funds in India

A drawback of investing in mutual funds in India is the higher cost associated with professional management by experienced fund managers, resulting in various fees and expenses that are ultimately borne by the investors.

Here is the list of disadvantages of mutual funds: 

Change In Fund Manager 

The fund manager’s decision may not always be based on an analytical decision but can be taken on personal bias. They can take a decision, which will only affect performance in the short term and not in the long term. Also, the fund manager can leave the AMC in which you have invested and change jobs, which will affect your mutual fund performance.

Over-Diversification

Diversification is the most important benefit of a mutual fund, but there may be over-diversification, which will increase the fund’s operating charges. This will reduce the chances of earning a stable return from a single stock.

Exit Load

You have to pay a certain percentage as an exit load when redeeming the mutual funds within the lock-in period. This is the biggest demotivator for investors who want to invest in mutual funds because an amount goes toward the exit load.

No Promised Returns 

Mutual funds do not promise any fixed returns and their price is reflected in their NAV, which changes daily. If the NAV goes down after your investment, then you are at a significant loss on your principal amount.

Lack Of Control 

The investors have zero control over where the fund manager invests the money. You can view the disclosure norms and SID of the scheme, but the ultimate decision to invest in any particular stock totally lies in the hands of the fund manager.

Need Extensive Research 

An investor who doesn’t have any financial knowledge may find it difficult to analyze the fund. They focus only on the fund’s NAV, which is not the sole indicator to analyze the fund’s performance. There are many metrics to study, such as alpha, beta, the Sharpe ratio, the Treynor ratio, and the standard deviation.

Past Performance Does Not Guarantee Future Performance

The past performance of a mutual fund scheme does not guarantee that it will replicate itself in the future. The investor should analyze the investment philosophy, transparency, and overall performance of a fund house over a certain period of time.

Different Tax Applicability 

Mutual funds are taxed differently on the basis of the dividend earnings, the holding duration of a particular stock, and whether the type of earnings is STCG or LTCG. The duration of the STCG and LTCG is different for equity funds, debt funds, and hybrid funds, which makes it difficult to understand the total taxation for each type of fund.

Importance of Mutual Funds

The importance of investing in mutual funds is that the investor is able to earn a higher return on invested amounts, which will outperform the benchmark index. The amount earned can be a good source for achieving long-term financial goals such as retirement planning, child education, etc.

The importance of investing in mutual funds are: 

Power Of Compounding

Mutual funds are the best funds to earn returns not just on the invested amount but also on the accumulated earnings. The amount you earn as earnings will get reinvested by the fund manager, which will increase the total earnings by multiple folds.

Rupee Cost Averaging 

With SIP, you can get the benefits of rupee cost averaging over the period because the cost of purchasing the units of a mutual fund will average down in the future. If the NAV is falling, then the investor will get the units at a very low average cost.

Start Anytime 

There is no correct time to start the investment in a mutual fund, especially with SIP. There is a saying in the stock market “You cannot time the market”. It means that it is difficult to predict the right time to buy or sell securities or mutual fund units as market conditions are constantly changing. 

Quick Processing

You can invest in mutual funds very quickly through your trading account or mutual fund account and track your performance anytime on the same app. Also, the amount you redeem by selling the units of a mutual fund will get credited to your bank account in just a few hours or a day or two.

Variety Of Investment Modes

The mutual fund provides various investment modes to choose from, such as SIP and lump sum. The amount can also be transferred to another scheme with STP (Systematic Transfer Plan) and can be withdrawn in regular installments with SWP (Systematic Withdrawal Plan).

Buy More Units, Pay Less

Just like with any wholesale purchase, you pay a lower price per unit. Similarly, if you purchase multiple units of a mutual fund at a time, the processing fees and commission charges will also be lower per unit of the mutual fund.

Do you want to expand your knowledge about mutual funds? We’ve got a list of must-read blogs that will help you do just that. Just click on the articles to find out more.

What Is Mutual Fund In Simple Words
Regulation of Mutual Fund
AMFI mutual fund
Tax Benefits of Investing in Mutual Funds
Is mutual fund safe
Structure Of Mutual Funds
Mutual Fund Cut Off Time
Difference between sip and mutual fund
What is SIP in Mutual fund?
Types Of Sip

Advantages and Disadvantages of Mutual Funds- Quick Summary

  • Investing in mutual funds comes with various advantages. For example, these funds are highly liquid which means as an investor you won’t face any trouble withdrawing your money from the fund. 
  • Some mutual funds like ELSS mutual funds function as a tax saving instrument for the investors.
  • Mutual funds are directly regulated by SEBI which means your investment funds will remain safe and protected. 
  • Among the disadvantages of mutual funds, changes in the fund manager can be an important factor. If the fund manager changes that particular scheme can get affected.
  • As an investor you won’t have any kind of control over your investment funds because they are handled by the fund manager of the chosen scheme. 
  • With the help of mutual funds you can accurately take advantage of the power compounding and grow your wealth.
  • You can start investing in mutual funds from anywhere at any time. 

Advantages and Disadvantages of Mutual Funds- Frequently Asked Questions

1. What are the advantages and disadvantages of mutual funds?

The advantages of mutual funds are portfolio diversification, liquidity, flexibility, and are regulated by SEBI. The disadvantages are over-diversification and no guaranteed returns.

2. What are the four main advantages of mutual funds?

  • Diversification: Mutual funds invest in various instruments such as stocks, debentures, G-sec, etc. 
  • Professional Management: They are managed by the fund manager. 
  • Invest in Small Amounts: SIP is available to invest in regular and small installment amounts.  
  • Tax savings scheme: The ELSS fund helps save on yearly tax liabilities. 

3. Should beginners invest in mutual funds?

Yes, beginners should invest in mutual funds, as they help start the investment journey with small amounts and low risk through diversification.

4. Are mutual funds good or bad?

Mutual funds are good for investors who are looking for diversification benefits along with professional management to reduce risk.

5. Why are mutual funds better than stocks?

Mutual funds can be better than stocks because you will get the benefit of the diversification of various stocks in a single fund, which will reduce the overall risk.

6. What are the advantages and disadvantages of mutual funds vs ETFs?

Mutual funds may give higher returns by beating benchmark index performance as compared to ETFs. The disadvantage of mutual funds is that they are traded only on a closing NAV, whereas an ETF is traded the whole day.

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