Benefits of Investing in Mutual Funds in India
Mutual funds as an investment option have been gaining popularity among Indians. They are deemed to be smart investment tools offering their investors many advantages. Although mutual funds involve market risks, smart investment strategies can help you optimise returns.
Before starting your mutual fund journey, you should consider knowing the benefits of mutual funds. This article will give you a list of the pros and cons of mutual funds to make your investment decision.
What Is a Mutual Fund?
A mutual fund is a scheme that pools money from investors and allocates it to different types of securities in the financial markets. Such funds are handled by fund houses, known as Asset Management Companies (AMCs). The securities can be company shares, debt, money market instruments, bonds, and other assets.
Investors invest in mutual funds on the basis of Net Asset Value (NAV). It represents the market value of the securities held in the portfolio of the scheme. The NAV is the price at which investors buy or sell mutual fund units. The NAV is a great indicator of a fund’s performance.
The NAV of a particular mutual fund is calculated by using the following formula:
NAV: (Total value of all securities – Total value of all liabilities) / Number of outstanding shares
The fund manager of a particular mutual fund scheme uses various investment strategies while allocating the assets among different securities. However, some funds might not need direct management by a fund manager. These funds usually try to mimic the patterns of popular indices and hence don’t need a fund manager’s help. These are known as passively managed funds.
Many investors prefer to invest in mutual funds because it helps to diversify the risks of your investment portfolio. If you are planning to invest in mutual funds, here are some of their benefits.
What Are the Benefits of Mutual Funds?
Here are the benefits of investing in mutual funds:
Diversification of the assets across different securities lowers the risk of loss for the investors. It may happen that when one of your securities underperforms, the other one might outperform. Hence, balancing risk is one of the primary advantages of mutual funds. The volatility of your overall portfolio remains in check under all market conditions. As there are various securities involved, the risk is mitigated for your overall investment.
- Professional assistance
One of the main reasons why many investors prefer mutual funds over the stock market is their expert fund management. As a beginner investor, you might not be thoroughly informed about the intricacies of the stock market. This is where a fund manager’s assistance will help you allocate your funds effectively.
Even if you are a seasoned investor, the stock market might not be very easy to understand for you or you might find it confusing and risky. It is a smart choice to let an expert handle the returns when you are not well-versed with the markets.
Unlike other investment options such as fixed deposits, most mutual funds do not have any lock-in period. You can make deposits and withdrawals as and when required. But there are some charges associated with a mutual fund, such as entry and exit load, which you should take into consideration before buying or selling units. These charges can significantly affect your returns.
- Affordable investment options
Affordability is one of the most important advantages of mutual funds. You can start your investment journey by selecting your preferred investment mode – lump sum or Systematic Investment Plan (SIP).
The lump sum method involves the investor investing a large amount at once. SIP or Systematic Investment Plan is another option by which you can start your journey with an amount as low as Rs. 500 per month. If you are a salaried investor, this might be your ideal investment method. You can invest quarterly or monthly as per your convenience through SIP.
You can start investing in mutual funds at any time and from anywhere. Asset Management Companies offer various channels for investment. You can make your investment in the following ways:
- Brokerage firms
- Online mutual fund investment platforms
- Banks and other financial institutions
This option makes mutual funds readily available to potential and existing investors. Additionally, you do not need a Demat Account to start investing in mutual funds.
As it has been previously discussed, there are all types of mutual funds for everyone. When one starts investing, some factors might need to be taken into consideration, such as salary, risk tolerance, investment objective and also expenses. One can begin investing with Rs. 500, and there are multiple types of mutual funds to choose from. Hence, one should remember to consider all these points and find the one type which suits their requirements.
- Security & transparency
Mutual funds are monitored by SEBI (Securities and Exchange Board of India) as per the SEBI Regulations 1996. SEBI has established rigid rules to protect the interest of investors, making trade transparent and safe for them. Additionally, SEBI uses a unique color-coding mechanism to make the investment process even safer. Here are what the different colours mean:
- Blue – Low risk
- Yellow – Medium risk
- Brown – High risk
Investors can also go through the details of the mutual funds such as the qualifications and expertise of the fund manager and the past performance of the AMC, before investing.
- Easy tracking
It might not be possible for investors to review their funds regularly. This is why the fund houses provide a detailed statement of the portfolio. You can ask the executives for the statement or download it from the fund house’s website.
- Tax-saving instrument
Certain types of mutual funds come with tax benefits. For example, if you invest in a mutual fund such as ELSS or Equity Linked Savings Scheme, you will be eligible to get a tax deduction of up to Rs. 1.5 lakh under Section 80C of the Income Tax Act. Other types of mutual funds are also eligible for a tax deduction or exemption depending on their types of returns.
- Low lock-in period
Units of most types of mutual funds can be easily bought or sold at their unit price anytime during working hours of the exchanges. However, some funds, such as ELSS, have a lock-in period of 3 years which is still lower than the same of other investment options such as FDs and PPFs.
Disadvantages of Mutual Funds
Even though mutual funds have a number of benefits, here are some points that you should consider before investing:
Even though diversification is what mitigates the risk associated with a mutual fund, investing in too many funds is not recommended. This may dilute your investment amount, lowering the chances for good returns. The thinner the investment, the lower the returns.
- Cost of investment
Fund houses levy certain fees on their investors that are used for the management and operations of the mutual fund scheme. These charges can sometimes affect your returns, as they have a direct link to the profitability of returns. Hence, it is advisable to check these fees, such as entry and exit load, before investing in mutual funds.
- Lock-in period
Some mutual funds, such as ELSS, come with a lock-in period of 3 years. Withdrawal of your investment before that may lead to huge penalties. Investors who wish to invest in highly liquid investment vehicles may not find this option suitable.
Advantages of Mutual Funds over Other Investment Options
Inflation has always put the market at risk. As a result, many investors choose to invest in mutual funds to benefit from compounding and beat inflation. However, investing your money in the right fund is important.
Here are some comparisons to show how mutual funds can be beneficial over some other popular investment options:
Mutual fund vs Fixed Deposit
|Mutual fund||Fixed Deposit|
|No fixed cap on the returns||Predetermined returns|
|Rate of return depends on the market conditions||Fixed interest rate throughout tenure|
|Returns are taxable as per their holding period or tenure and the type of fund||Returns are taxable as per the tax slab of the investor|
Mutual fund vs Public Provident fund
|Mutual fund||Public Provident fund (PPF)|
|No lock-in period except for tax-saving mutual fund or ELSS||Comes with a lock-in period of 15 years|
|High liquidity||Low liquidity|
Mutual fund vs ULIP (Unit Linked Insurance Plan)
|More transparent in terms of fees and investment details||Less transparent in terms of charges and investment details|
|Lower expenses||Relatively higher expenses|
|Considerably profitable returns||Relatively lower returns|
|No lock-period except for ELSS||Lock-in period of 5 years, depending on the investment scheme|
After knowing the benefits of mutual funds, you now know that the right mutual fund for you has the potential to generate a significant amount of return. However, there are many sub-categories of mutual funds out there that have their own set of benefits and disadvantages. Thus, you are advised to analyse a mutual fund scheme thoroughly before making any investment choices.
Frequently Asked Questions
What are the charges that mutual funds levy?
Entry load, exit load, and expense ratio are the three different types of charges a mutual fund charges from its investors. Investors pay an entry load while joining a scheme. Exit load is the fee payable by the investor during the withdrawal of investment. The expense ratio is the ratio between the fund’s net assets and its expenses.
How to avoid missing out on timely SIP payments?
You can opt for an automatic payment option to make sure your payments are timely deposited. You can submit a SIP mandate by instructing your bank account to automatically deduct the SIP amount on time. You will receive a mail or message informing you of the same.
What are the popular types of mutual funds?
The most sought-after mutual funds are equity funds, debt funds and hybrid funds. As the names suggest, equity funds primarily invest in equities of companies; debt funds invest in various debt securities like bonds, treasury bills, etc., and hybrid funds invest in a mixture of both.
Can I cash out mutual funds at any time?
Yes, most mutual funds do not come with a lock-in period. As long as it is an open-ended scheme, you can withdraw your investment any day, at any time. However, it may take around 1-2 days for the amount to get transferred from the mutual fund to your linked bank account, depending on the type of mutual fund.