Mutual Funds InvestmentToday, mutual funds have become the most popular investment option for retail investors as it is an indirect but safer way of investing in the stock market! But before you start investing in mutual funds simply because your friends, colleagues and neighbours are doing it, you need to be aware of the advantages of mutual funds and the disadvantages of mutual funds. As we know, mutual funds pool money from various individuals and invest collectively in - stocks, bonds or other asset classes as per the investment objective of the scheme. In this article, we will discuss the crucial advantages of mutual funds and the disadvantages of mutual funds. Also, understand if mutual funds are really worth the hype.
Advantages of Mutual funds
1. Professional ManagementThe most important advantage of Mutual funds is that they are managed by experienced fund managers known as an asset manager appointed by the fund house. These managers research companies based on micro and macro economic factors. Later, they decide the best stocks to invest in so that maximum profit can be generated for the unitholders.
2. DiversificationAnother important advantage of Mutual funds is that offer ample diversification. The pooled money is invested in multiple stocks across sectors, market capitalisation and asset classes depending on the investment objective of the scheme. So, the loss incurred in one sector or asset class is offset by profit made in another sector or asset class. Diversification reduces the overall risk of the portfolio.
3. LiquidityMutual funds are highly liquid as they can be easily bought and sold in a short term during market hours. However, close-ended mutual funds, interval funds, and equity funds - (ELSS funds) are an exception as they have a lock-in period and cannot be readily liquidated.
4. CostAn important advantage of mutual funds is their low cost. Due to huge economies of scale, mutual funds schemes charge as little as 1% - 2.50% as fund management fees.
5. Tax EfficiencyA unique advantage of mutual funds is that they offer tax benefits. Investment in ELSS is exempt under section 80C upto Rs 1.5 Lakhs. Long term capital gain tax on equity mutual funds is 10% over Rs 1 Lakh in a financial year. If your overall gains do not exceed Rs 1 Lakh then you are exempt from paying taxes. In case of debt mutual funds, you get the benefit of indexation, which is not available in other investment options. [Suggested reading: Tax saving options in India 2021]
6. AffordabilityMutual funds are also affordable as you can start from as little as Rs 500 per month. You can also opt for SIP or lumpsum investment based on your budget. The affordability of mutual fund is the biggest advantage of mutual funds, as it allows retail investors to start investing with a small amount.
Key Takeaways on the Advantages of Mutual Funds
- You can start from as little as Rs 500 per month.
- You can invest every week/month/fortnight via systematic investment plans or make lumpsum investments as per your budget.
- Your portfolio is managed by an expert fund manager who takes investment decisions on your behalf as per the objective of the scheme.
- Mutual funds are tax-efficient and ELSS funds are exempt upto Rs 1.5 Lakhs under section 80C of the income tax act.
Disadvantages of Mutual FundsLet’s take a look at various disadvantages of mutual funds.
1. CostsYou must be surprised to see ‘cost’ both as an advantage and disadvantage of mutual funds! Some mutual funds have high costs associated with them and if you exit before the stipulated period, then you also incur exit load charges.
2. Dilution of FundsThe biggest disadvantage of a mutual fund is diversification. Diversification has an averaging effect on your investments. It saves you from suffering major losses, But as a result of this, it also prevents you from making any major gains! Hence, It is recommended that you do not invest in too many mutual funds and over-diversify the portfolio.
3. Lock-in PeriodAnother disadvantage of Mutual fund is that some mutual funds are like ELSS funds and come with a lock-in period of three years. During this lock-in period, you cannot withdraw your invested amount for 3 years. Additionally, if you invest in close-ended funds, then you will not be able to liquidate these investments in case of any emergencies.
4. Fluctuating ReturnsMutual fund returns are not guaranteed and keep on fluctuating as per the market. Hence investors need to be aware of the risk profile of the fund before investing.
Key Takeaways on the Disadvantages of Mutual Funds
- Exit loads are applicable if you sell your investments within a specified time period.
- Mutual funds are subject to market risk and not guaranteed.
- Some mutual funds come with a lock-in period of 3 years.