Advantages and Disadvantages of Mutual Funds
Now-a-days, Mutual Funds have become preferred investment option for majority as they are delivering decent returns when compared to the traditional investment schemes. Apart from the returns, these are also comes with certain advantages like Convenience and Risk diversification which are some of crucial factors to be considered for investing.
As we all know, every investment option will have pros and cons, mutual funds also comes with certain disadvantages as well.
In this article, we will understand the advantages and disadvantages of Mutual Funds in detail.
If you are a complete beginner to mutual fund investment, I suggest you to read the complete article on the mutual funds basics linked down below.
Read full article on Mutual Funds here: Mutual Funds Basics for Beginners (Learn it the right way)
Now, let’s understand advantages and disadvantages of mutual funds.
Advantages of Mutual Funds
Following are some of the advantages associated with mutual fund investment. Let’s understand in detail.
1. Professional Management: Mutual fund schemes are run by a professional management. Each scheme will have a dedicated fund manager who takes care of the portfolio as per the investment objective of the scheme. These fund managers possess relevant domain experience and expertise in effectively managing the fund for generating optimum returns.
Since many investors may not have a basic understanding how the stock market works, investing in Stocks, Bonds or any other stock market-related instruments is risky. However, with the help of a professional fund managers it’s easy for investors to generate income or accumulating wealth from mutual fund investment.
2. Risk Diversification: Diversifying the risk is always important while investing. Mutual Funds are one of the best diversified investments since the investment is not limited to a single company or a sector in the market. Depending on the scheme’s investment objective, it may invest in various opportunities which may include Equity, Debt and Gold etc.
As the mutual fund invests in a variety of stocks and sectors, your investment will get good risk diversification. So even if one investment in the portfolio doesn’t perform well, it will be counterbalanced by other investments to maintain a reasonable return.
3. Convenience: It is the most convenient option for many small investors. One can start from a minimum investment of Rs. 500 (some funds even start with Rs. 100 also) and in addition SIP option is also available for those who want to invest regularly.
Another advantage of mutual fund schemes is, that sometimes we may not be in a position to invest in the stocks of big companies whose share price is considerably high. Imagine, if you want to invest in the stock of MRF (share price as of 18th June is Rs. 1,25,850), as an individual investor you may not invest in such a pricy stocks. Even if you invest, if anything goes wrong with the company your entire investment is gone.
But with the help of mutual funds, even though you may not directly invest in a particular stock but you can choose a mutual fund scheme which will invest a certain portion of their funds either in a particular company or in a particular sector.
4. Liquidity: Liquidity is one of important factor one must consider before investing. Because after investment, if you are unable to withdraw the money for your needs it doesn’t serve the basic purpose. So always consider liquidity as your highest priority.
Generally most of the mutual schemes provide high liquidity except close ended schemes. As per the existing settlement mechanism, all transactions shall be settled on T+2 basis i.e. settlement shall happen within 2 working days from the day of transaction. So when redeemed, amount will be credited to the bank account within 3-4 working days.
If you can wait for such period, you need not worry about liquidity of mutual fund schemes. Instead, if you cannot wait for such long, keep some emergency fund in your bank account and invest the surplus amount only in MF schemes.
5. Low-cost: Sometimes returns generated by the investment will be eaten up by the cost associated with it. Hence identifying the costs involved is important to improve return from investment.
Mutual fund schemes also charges certain amount as expense for managing the fund which is known as Total Expense Ratio i.e. TER. When compared to the quantum of returns different MF schemes are generating these days, the TER charged by them is much less.
Due to large economies of scale, particularly for funds with higher AUM, schemes will have a lower expense ratio and hence such schemes will result in higher NAV which is beneficial to the investors. Schemes with lower AUM may have a higher expense ratio and thus leads to lower NAV.
6. Regulated: Mutual Funds are regulated by market regulator SEBI and also all mutual funds are governed by SEBI (Mutual Fund) Regulations, 1996. In addition, SEBI from time to time lays down stringent rules for the protection of the investors and to enable transparency in the financial market.
7. Tax Benefits: Certain mutual fund schemes also comes with tax benefits under Income Tax Act 1961 as well. Schemes like Equity Linked Savings Schemes (ELSS) are eligible for tax benefits under sec 80C of the Income Tax Act upto Rs. 1.50 lakh under Old tax scheme. Those who are opting for new tax scheme are not eligible for these tax benefits.
If tax benefits from investing are the priority, then make sure to consider equity-oriented mutual fund schemes only as the debt fund schemes are not eligible for tax benefits.
Disadvantages of Mutual Funds
Though there are many advantages, Mutual funds also comes with certain disadvantages as well. They are:
1. Exit load: Exit load in simple terms is, charge levied when you exit from the scheme before the minimum investment tenure. Some schemes specifies it as 6 months and some may keep it as 1 year as minimum investment tenure.
Most of the time we don’t consider exit load as one of the factors for investing. But a higher exit load will eat up the earnings of the investors. So always make sure to consider this before investing into any scheme.
2. Capital Gain Tax: When you redeem or sell your mutual fund units, any profit resulting from such transaction is taxable under Income Tax Act, 1961. It will be known as Capital Gain in income tax terminology.
Depending on the period of holding (i.e. period from buy date to sell date) of such units, either such gain will be called Short Term Capital Gain (STCG) or Long Term Capital Gain (LTCG).
Both STCG and LTCG are taxable under the Income Tax Act. However, taxation of the mutual funds varies as per the nature of the scheme (i.e. Equity, Debt and Other mutual funds). Depending on the period of holding and the type of fund, capital gain will be taxed at different rates. So always bear in mind that the entire profit/gain from the sale of mutual fund units is not exempted.
3. Liquidity: One should consider liquidity carefully as it can be seen both as an advantage and disadvantage as well. Because not all mutual fund schemes are liquid. Even if they are liquid, it will take 3-4 working days to get your money credited to the bank account (except for liquid funds). So in case of emergency, if you are left with no other option that could be a problem.
Basically, mutual fund schemes are broadly divided into two types. Open-ended schemes and close-ended schemes. Open-ended schemes are highly liquid instruments as the entry into and exit from the scheme is not restricted. So you can enter and exit anytime you wish.
But close ended schemes can be purchased only during specific period and redemption is also possible only after maturity. So there are restrictions on both entry and exit also. Hence, please be aware of these both schemes while investing in mutual funds. If you are looking for better liquidity, go for open ended schemes. Instead, if liquidity is not a problem for you then you may even consider close ended schemes as well.
4. Market Risk: Since most of mutual fund schemes (except debt schemes) deals with stock market, there is always risk associated with your investment. Though mutual fund scheme’s investments depends on their investment objective, most of their investments are parked in stock market only. As we all aware that stock market is highly volatile, expected returns may not be guaranteed at all times.
5. Invest for longer tenure :
Sometimes to achieve the desired returns, one should hold their investments for a longer period of time. This is particularly holds true with the mutual funds. Because exiting early from mutual fund schemes may not give good returns. If the market is highly volatile when you are exiting, the entire return fetched till date may become zero and in such case the scheme may not give any return on your investment.
It does not mean holding for longer tenure will always gives a better return. Sometimes investments for shorter duration also performs well. It all depends on the market conditions when you are dealing with mutual funds. If market is positive you will get a good return and if market is negative it will negatively impact your returns.
Conclusion
Any investment option will come with certain advantages and disadvantages as well. There is no one investment option which has all advantages over the other. And also different individuals invest in various investment options as per their needs and investment objectives.
It is always important to get the complete picture of any investment, then decide which suits better as per your needs and objectives. In the current scenario, if you want to achieve inflation adjusted returns and at the same time you don’t want to expose all your investment to complete market exposure, then mutual fund investment is the best choice.
I hope you enjoyed reading this article, Thank you for your time.
