What is a Mutual Fund?
Meaning of a Mutual Fund: – A mutual fund is a company that collects money from many investors and invests the money in securities such as stocks, bonds, and short-term debt or loans. The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds. Each share represents an investor’s part ownership in the fund and the income it generates.
A mutual fund is a type of investment vehicle that contains a portfolio of stocks, bonds, or other securities. Mutual funds give small or individual investors access to a variety of portfolio, professionally managed portfolios at a low cost. Mutual funds collects the money from an investment community and then use that money to buy other securities, usually shares and bonds. The value of a mutual fund company depends on the security performance it decides to purchase. Therefore, when you buy a unit or share in a mutual fund, you are buying the performance of its portfolio or, more accurately, part of the value of the portfolio.
Investing in a share of a mutual fund is different from investing in shares of stock. Unlike stock, mutual fund shares do not give its holders any voting rights. A share of a mutual fund represents investments in many different stocks (or other securities) instead of just one holding. The average mutual fund holds over a hundred different securities, which means mutual fund shareholders gain important diversification at a low price.
Many people find mutual funds complicated or intimidating. We are going to try to make it simple for you at its very basic level. Essentially, it is the money pooled by a large number of people (or investors) that makes up a mutual fund. This fund is managed by a professional fund manager.
It is a trust that collects money from multiple investors who share a common investment objective. Then, it invests the money in equities, bonds, money market instruments and/or other securities. Each investor has units, which represent a portion of the fund’s holdings. The income/gain generated from this collective investment is distributed proportionately among the investors after deducting certain expenses by computing the “Net Asset Value or NAV” of the scheme.
Mutual fund invests in a basket of securities. As the prices of these securities change (for stocks and some bonds) or as a fund earns interest on its bonds, its value changes. Gains in stock/bond prices send higher prices and vice versa. So as the value of the fund increases, so does your investment value.
- When you sell your funds: – In this case, you earn a capital gain. Capital gain is the return on your investment when you sell your mutual fund units. It is the difference between the market value of your mutual fund units at the time of sale and the cost of such units. The profit comes from the appreciation in the value of your fund. If the sale price is less than your investment cost, you have incurred a capital loss.
- When you earn dividend on your fund: – This is when a mutual fund declares dividend out of its accumulated profits. This accumulated profit can be in the form of securities sold for profit, interest earned on bonds or dividends earned on shares.
What are the types of Mutual Fund?
The types of Mutual Funds are as follows: –
- Money Market Funds: – The money market funds consists of safe (risk-free), short-term debt instruments, mostly government Treasury bills. This is a safe place to keep your money. You won’t get great returns, but you will not have to worry about losing your money. A typical return is slightly higher than the amount you can earn from the standard check or savings account and is slightly less than the certificate of deposit (CD). These funds invest in short-term fixed income securities such as government bonds, Treasury bills, bankers’ acceptances, commercial paper and certificates of deposit. They are generally a safer investment, but with lower potential returns than other types of mutual funds. Canadian money market funds try to keep their net asset value (NAV) stable at $10 per security.
- Fixed Income Funds: – A fixed income mutual fund focuses on investments that pay a fixed rate of return, such as government bonds, investment-grade corporate bonds and high-yield corporate bonds. Their goal is to get money into the fund regularly, mostly through the interest that the fund earns. High-yield corporate bond funds are generally riskier than funds that hold government and investment-grade bonds. These mutual funds are likely to pay higher returns than certificates of deposit and money market investments, but bond funds aren’t without risk. Because there are many different types of bonds, bond funds can vary dramatically depending on where they invest.
- Equity Funds: – Equity funds invests principally in stocks. These funds are intended to grow faster than money market or fixed income funds, so there is usually a higher risk that you could lose money. You invest your money in the fund via SIP or lumpsum which then invests it in various equity stocks on your behalf. The consequent gains or losses accrued in the portfolio affect your fund’s Net Asset Value (NAV). You can choose from a variety of equity funds, including growth stocks (which usually don’t pay dividends), income funds (which hold stocks that pay large dividends), value stocks, large-cap stocks, Mid-cap stocks are included, small-cap stocks, or a combination of these. Equity Funds are either Active or Passive. In an Active Fund, a fund manager scans the market, conducts research on companies, examines performance and looks for the best stocks to invest. In a Passive Fund, the fund manager builds a portfolio that mirrors a popular market index, say Sensex or Nifty Fifty. Mutual funds’ popularity among investors continues to rise, and equity funds are by far the most popular type of mutual fund. Of the 55 million American households that invested in mutual funds in 2016, better than 80% had equity funds in their portfolio, according to a study by the Investment Company Institute, an industry group.
- Balanced Funds: – Balanced funds invest in a mix of equity and fixed income securities. They try to balance the objective of achieving high returns against the risk of losing money. Most of these funds follow a formula for dividing the money between different types of investments. They have higher risk than fixed income funds, but less risk than pure equity funds. Balanced fund is a mutual fund that invest money across asset classes, including a mix of low-to medium-risk stocks and bonds. Balanced funds invest with the goal of both income and capital appreciation. Typically, balanced funds stick to a fixed asset allocation of stocks and bonds, such as 70% stocks and 30% bonds. Bonds are debt instruments that usually pay a stable, fixed rate of return.
- Index Funds: – An index fund is a portfolio of stocks or bonds designed to match the composition and performance of a financial market index. An index fund (also index tracker) is a mutual fund or exchange-traded fund (ETF) designed to follow certain preset rules so that the fund can track a specified basket of underlying investments. The objective of these funds is to track the performance of a specific index such as the S&P/TSX Composite Index. The value of a mutual fund will go up or down when the index goes up or down. Index funds typically have lower costs than actively managed mutual funds because the portfolio manager is not required to do as much research or make as many investment decisions. These funds are often designed with cost-sensitive investors in mind.
- Specialty Funds: – A mutual fund or any other fund that specializes in the securities of a particular industry, sector or region is called a Speciality Fund. Speciality funds’ performance depends on the performance of the industry or the region where the investment has been made. Because there is no sectoral or industry-wise diversification in this type of investment, speciality funds are considered as a high-risk investment due to high concentration risk. These funds focus on specific mandates such as real estate, commodities or socially responsible investing. For example, a socially responsible fund may invest in companies that support environmental management, human rights, and diversity, and may avoid companies involved in alcohol, tobacco, gambling, weapons, and the military.
- Exchange Traded Funds (ETFs): – Exchange-traded funds, commonly known as ETFs, are a collection of various securities such as bonds, shares, money market instruments, etc., that usually track the underlying assets. Simply put, ETFs are epitome of diversified investment. They offer the best attributes of two popular financial assets – mutual funds and stocks. Unlike with mutual fund shares, retail investors can only purchase and sell ETF shares in market transactions. That is, unlike mutual funds, ETFs do not sell individual shares directly to, or redeem their individual shares directly from, retail investors. Instead, ETF sponsors enter into contractual relationships with one or more financial institutions known as “Authorized Participants.” Authorized Participants typically are large broker-dealers. Only Authorized Participants are permitted to purchase and redeem shares directly from the ETF, and they can do so only in large aggregations or blocks (e.g., 50,000 ETF shares) commonly called “Creation Units.”
- Liquid Mutual Funds: – Liquid Mutual Funds are investment plans that will allocate funds primarily to money market instruments such as treasury bills, term deposits, certificate of deposits, commercial papers, etc. These funds come with a lower maturity period. Liquid funds are a type of mutual funds that invest in securities with a residual maturity of up to 91 days. Assets invested are not tied up for a long time as liquid funds do not have a lock-in period. Return is not guaranteed as the performance of fund depends upon how the market performs unlike fixed deposits which are not dependant on the market. An investor looking for better returns prefers investing in a liquid fund over fixed deposit. In simple words, a liquid fund is a subset of a debt mutual fund. The fund portfolio invests in debt instruments that are of high credit quality. They invest in money market instruments like certificates of deposits (CD), treasury bills(T-bills) and commercial paper (CP) for up to 91 days.
Broad variants of Mutual Funds
- Direct Mutual Fund vs. Regular Mutual Fund: – Direct Mutual Fund is the type of mutual fund that is directly offered by the asset management company (AMC). In other words, there is no involvement of third party agents such as brokers or distributors. Since there are no third party agents involved, there are no commissions and brokerage. Hence the expense ratio of a direct mutual fund is lower. Thus, the return is higher due to a lower expense ratio. Regular Mutual Funds are those mutual fund plans that are bought through an intermediary. These intermediaries can be brokers, advisors, or distributors. A regular plan is when you use the services of a distributor or agent to whom the AMC pays a commission. The intermediaries charge the fund house a certain fee for selling their mutual funds. The AMCs usually recover this fee through expense ratio. The expense ratio for regular mutual funds is slightly higher than direct mutual funds. Hence the returns tend to be a little higher for direct plans. A regular plan best suits investors who do not have the knowledge about the market nor the time to monitor their portfolio.
- Active Mutual Funds and Passive Mutual Funds: – In an Active Mutual funds, the fund manager selects securities with the aim of beating the benchmark. Actively managed funds, financial managers have to do a lot of industry research and accordingly move funds in various securities based on market performance. That makes active management costlier as there is a lot of research and other work put in towards the investment. The securities in an active portfolio and their weighting in the portfolio will be different from the benchmark index. A Passive Mutual Fund is a type of fund that religiously tracks a market index to allow a fund to fetch maximum gains. In a passive fund, the fund manager replicates the index with the exact same stock and in the same ratio. The fund manager does not actively choose what stocks the fund will be comprised of, which is the case in an active fund. This usually makes passive funds easier to invest in than active funds. Its objective is only to give returns in the market and not to beat it. Index funds and ETFs are passive funds.
- Open Ended and Close Ended Funds: – Open-End Funds (which most of us think of when we think mutual funds) are offered through a mutual fund company that sells shares directly to investors. An open-ended mutual fund allows investors to invest in and redeem a fund at any time. Hence the fund gets steady flow and redemption. Units are allotted to investors at the prevailing NAV at the time of investment. Closed-End Fund has a fixed number of shares offered by an investment company through an initial public offering. A closed-end fund is open for subscription only for a specified period, and investments need to be made only in this period. Closed-end funds also have a maturity date, before which investors cannot redeem their investments. However, to provide an exit route, closed-end mutual fund units are listed on stock exchanges through which the units can be sold to another investor. However, little involvement is seen in this pathway.
Diversify with Investing Style
Portfolio managers may have different investment philosophies or may use different investment styles to meet a fund’s investment objectives. Choosing funds with different investment styles allows you to diversify beyond the type of investment. This can be another way to reduce investment risk.
4 Common Approaches to Investing: –
- Top-to-Bottom Approach: – It looks at the bigger economic picture, and then finds industries or countries that look like they’re going to do well. Then invest in specific companies within the chosen industry or country.
- Bottom-Up Approach: – This approach focuses on selecting specific companies that are performing well, irrespective of the prospects for their industry or economy.
- Combination of Top-Down and Bottom-Up Approaches: – A portfolio manager managing a global portfolio can decide which countries to favour based on a top-down analysis, but not each based on a bottom-up analysis Build a portfolio of stocks within the country.
- Technical Analysis: – Attempts to predict the direction of investment prices by studying past market data.
Top Mutual Fund Companies in India
Here is the list of top Mutual Fund Companies in India: –
- SBI Mutual Fund: – SBI Mutual Fund is one of the well-recognised company in India. The company is present in the Indian Mutual Fund industry for more than three decades now. It was launched in the year 1987. The user base of SBI Mutual Fund is more than 54 Lakhs. It offers schemes across various categories of funds to cater the diverse requirements of the individuals. Investors who wish to invest in SBI Mutual Fund schemes, here are some of the top funds that you can choose as per your investment needs & objectives. SBIFMPL is a joint venture between the State Bank of India, an Indian public sector bank, and Amundi, a European asset management company.
- ICICI Prudential Mutual Fund: – Launched in the year 1993, ICICI Mutual Fund is one of the biggest Asset Management Companies in the country. ICICI Prudential Mutual Fund is the second largest asset management company in India. The fund house offers a broad spectrum of solutions for both corporate and retail investments. ICICI Mutual Fund Company has been maintaining a strong customer base by delivering satisfying product solutions and innovative schemes. There are various Mutual Fund schemes offered by the AMC like equity, debt, hybrid, ELSS, liquid, etc. Here are a few top performing schemes of ICICI MF that you could prefer Investing in.
- HDFC Mutual Fund: – HDFC Mutual Fund is one of the most well-known AMC’s in India. It launched its first scheme in 2000 and since then, the fund house has been showing a promising growth. Over the years, HDFC MF has won the trust of several investors and has placed itself amongst the top performers in India. Investors who are keen to invest in HDFC Mutual Fund, here are some of the best schemes to choose.
- DSP BlackRock Mutual Fund: – DSP Black Rock is the largest listed AMC in the world. It offers a variety of Mutual Fund schemes to cater the diverse investment needs of the investors. It has a performance record of more than two decades in investment excellence. Here are some of the best performing DSPBR Mutual Fund schemes that you can consider while investing.
- Aditya Birla Sun Life Mutual Fund: – Birla Sun Life Mutual Fund offers solutions that can help investors achieve their financial success. The fund house specializes in various investment objectives like tax savings, personal savings, wealth creation, etc. They offer a bundle of Mutual Fund schemes like equity, debt, hybrid, ELSS, Liquid Funds, etc. The AMC is always known for its consistent performance. So, investors can prefer adding the schemes of BSL Mutual Fund in their portfolio to earn optimal returns.
- Mirae Asset Large Cap Fund: – Mirae Asset Large Cap Fund-Growth is an open-ended large-cap equity mutual fund scheme. It predominantly invests in equity and equity-related securities of large-cap companies. The fund aims to achieve long-term capital appreciation over the investment tenure. The fund was previously known as Mirae Asset India Opp Reg Gr. It aims to outperform the benchmark with risk lower than the benchmark. Mirae Asset Investment Managers (India) Private Limited manages the fund with the fund manager being Mr. Gaurav Misra and Mr. Harshad Borawake.
- Kotak Mutual Fund: – Since its launch in the year 1998, Kotak Mutual Fund has grown into one of the well-known AMCs in India. The company offers a variety of Mutual Fund schemes to cater the diverse requirements of the investors. Some of the categories of the Mutual Fund includes equity, debt, hybrid, liquid, ELSS and so on. Investors can plan their investments and refer to these top-performing schemes by Kotak Mutual Fund.
- L&T Mutual Fund: – It caters to the investment needs of investors through various mutual fund schemes. L&T Mutual Fund follows a disciplined approach to investment and risk management. The company emphasizes to deliver a superior long-term risk-adjusted performance. The AMC was launched in the year 1997 and since it has gained an immense trust amongst its investors. Investors can choose schemes from a host of options like equity, debt, Hybrid Fund, etc. Some of the best performing schemes are: – L&T Emerging Businesses Fund, L&T India Value Fund, L&T Midcap Fund, etc.
- UTI Mutual Fund: – UTI Flexi Cap Fund announced IDCW of 45% under both regular and direct plans subject to availability of surplus on a record date. NAV is expected to fall to the extent of payout and statutory levy. On the record date of 12th August 2021 all registered holders of IDCW regular and direct plan will be eligible. A fund manager manages the funds and investment amount of an investor in order to bring in higher returns possible. They help an investor achieve his financial goal thereby making portfolio decisions for mutual fund investment.
- Tata Mutual Fund: – Tata Mutual Fund has been operating in India for more than two decades. Tata Mutual Fund is one of the well-reputed fund houses in India. The fund house has been able to win the trust of millions of customers with its consistent performances top-notch service. Tata Mutual Fund offers various categories such as equity, debt, hybrid, liquid & ELSS, investors can invest as per their investment needs & objectives.
- Reliance Mutual Fund: – Since its launch in the year 1995, Reliance Mutual Fund has been one of the fastest growing Mutual Fund company in the country. The fund house has an impressive track record of consistent returns. Reliance Mutual Fund offers a variety of schemes that can cater to the diverse needs of the investors. Investors can choose funds as per their investment objectives and invest according to their risk appetite.
- Axis Bluechip Fund: – Axis Asset Management Company Limited manages assets worth 251,316 crores and was set up on 13 January 2009. It’s current offering of mutual fund schemes includes 33 equity,93 debt and 35 hybrid funds. Axis Bluechip Fund (Growth) is recommended for investment within large cap mutual funds. Large cap funds provides inflation beating growth over the long term and is suitable for investment objectives with duration of 10-15 years or longer (minimum 5 years).
- Parag Parikh Equity Fund: – Parag Parikh Flexi Cap Fund-Growth is an open-ended dynamic and diversified equity mutual fund scheme. It invests in large-cap, mid-cap, and small-cap stocks of Indian as well as foreign companies. On average, the fund invests 65% of its assets in stocks of listed Indian companies. Such an investment benefits the scheme with respect to Favourable capital gains taxation under Direct Taxes. The fund strongly believes in the principle of compounding and hence provides only the Growth option. The fund is more suitable for an investor who is seeking investment for a minimum period of 5 years. The fund aims to provide long-term capital appreciation.
Mutual Funds Categories
- Equity Funds: –
- Multi-Cap fund: – Multi-cap fund schemes invests at least 65% of the total assets in in equity and equity-related instruments.
- Large Cap Fund: – Large cap fund schemes are required to make a minimum investment of 80% of the total assets in the equity and equity related instruments of large cap companies.
- Large and Mid-Cap fund: – Large and Mid-Cap fund schemes need to make a minimum investment of at least 35% of total assets in both large cap and mid cap companies each i.e., 70% total investment both large cap and mid cap companies.
- Mid-Cap Funds: – 65% of the total assets should be invested in the equity and equity related instruments of mid cap companies for this scheme.
- Small Cap Fund: – The small cap fund investment required by the scheme in equity and equity-related instrument of small cap companies is 65% of the total assets.
- Dividend Yield Funds: – Dividend yield funds scheme primarily investments in dividend yielding stocks. The minimum investment required is 65% of the total assets in equity instruments.
- Value Fund: – Value Fund follows a value investment strategy and is mandated to invest at least 65% of the total assets in equity and equity related instruments.
- Contra Fund: – The contra fund scheme should have a minimum investment of 65% of the total assets in equity instruments. A contrarian investment strategy should be followed by these schemes.
- Focused Fund: – This scheme invests in equity & equity-related instruments of a limited number of companies not exceeding 30. At least 65% of the total assets will be invested in a forementioned instruments of companies across market capitalization.
- Sectoral/Thematic: – The investment should be made in a particular sector or particular theme only. The minimum investment for the same in equity and equity-related instruments is 80% of the total assets.
- ELSS : – An open-ended equity linked saving scheme has a compulsory holding period of 3 years but provides tax benefit to the investor. The scheme is required to make a minimum investment of at least 80% of the total assets in equity and equity-related instruments.
- Debt Funds: –
- Overnight Fund: – As the name suggests, these schemes invest in securities with a maturity of 1 day.
- Liquid Funds – Liquid fund schemes invest in debt and money markets with a maximum maturity of up to 91 days only.
- Ultra Short Duration Fund: – These schemes predominantly invest in debt and money market instruments with a Macaulay duration period of 3 to 6 months.
- Low Duration Fund: – This scheme invests with a Macaulay duration of 6 to 12 months and the investment is primarily done in debt and money market instruments.
- Money Market Fund: – These schemes invest in money market instruments with a maturity of up to one year.
- Short Duration Fund: – As the name suggests, these schemes try to invest in debt and money market instruments while ensuring that the Macaulay duration of the portfolio remains around 1-3 years.
- Medium Duration Fund: – Medium Duration fund schemes invest in debt and money market instruments while ascertaining that the Macaulay duration of the portfolio remains around 3 to 4 years.
- Medium to Long Duration Fund: – These schemes investment into debt and money market instruments with Macaulay duration of the portfolio around 4 to 7 years.
- Long Duration Fund: – The portfolio of these schemes has a Macaulay duration of over 7 years. Investment is predominantly made in debt and money market instruments.
- Dynamic Bond: – These schemes follow a dynamic approach towards maturity of securities in the portfolio. Investments are done across durations.
- Corporate Bond Fund: – These schemes invest at least 80% of total assets in only high rated corporate bonds.
- Credit Risk Fund: – The investment is made in instruments below the high rated instruments. The minimum investment required in corporate bonds for the same is 65% of the total assets.
- Banking and PSU Funds: – These funds need to have a minimum of 80% of investment of total assets in debt instruments of bank, public sector undertakings and public financial institutions.
- Gilt Fund: -The minimum investment requirement for gilt funds is 80% of the total assets in Gsecs across its maturity.
- Floater Fund: – These funds are mandated to have a minimum investment of at least 65% of the total assets in floating rate instruments.
- Hybrid Schemes: –
- Conservative Hybrid Fund: – The fund is required to make investments in both equity and debt instruments. The investment requirement for equity & equity-related instruments is between 10% to 25% of the total assets and that for debt instruments it is 75% to 90% of the total assets.
- Balanced Hybrid Fund: – The minimum investment requirement for this fund scheme is 40% to 60% of the total assets for both equity as well as debt instruments. Arbitrage is not allowed in this scheme.
- Aggressive Hybrid Fund: -These funds invest in both equity & equity-related and debt instruments with a minimum requirement of 65-80% for the former and 25-30% for the latter.
- Dynamic Asset Allocation or Balanced Advantage: – This scheme is free to dynamically change the investment in equity & debt instruments.
- Multi Asset Allocation: – These hybrid fund schemes allocate minimum 10% in three asset classes. This scheme is mandated to invest at least in 3 asset classes.
- Arbitrage Fund: – As the name suggests, these schemes follow an arbitrage strategy and are required to invest 65% of the total assets in equity & equity-related instruments.
- Equity Savings: – This scheme invests in both equity and debt securities. The minimum requirement for equity & equity-related instruments is 65% of the total assets and for debt instruments it is 10% of the total assets. It is necessary to show the minimum hedged and unhedged in SID.
What are the advantages of Mutual Funds?
The advantages of Mutual Funds are as follows: –
- High Returns: – Mutual funds have a proven track record of generating better returns than other investment options. When you invest in a mutual fund the associated risk is relatively low as most of the mutual fund schemes spread the investment in multiple assets and sectors for reducing the risk. Hence, if any one of the sectors faces a loss then the gains from the other sectors will compensate the amount that you have lost. This risk mitigation benefit makes mutual fund investments a smart investment option compared to other investments.
- Diversification: – Diversification is the biggest advantage of mutual funds. When you invest in mutual funds, your investment is split and invested in different stocks. Doing so reduces the overall risk of the fund. Diversification also increases your chances of earning higher returns as you get a chance to participate in the growth of all the top stocks. Though mutual fund investments are subject to market risks, the advantage is that the associated risk can be diversified. It is completely up to the risk appetite of the investor to decide how much risk he/she is ready to take. While a high-risk fund tends to offer higher returns, the chances of loss in these are equally high. So, if you are not willing to take a huge risk you have the option to choose low or medium-risk funds. A medium-risk fund tends to balance the risk and give out a medium return and a low-risk fund has lower risks and gives the lowest returns. Thus, based on your risk-taking ability you can diversify the risk by choosing a suitable fund matching your requirement.
- High Liquidity: – When making investments in mutual funds, an investor gets options for liquidity as well. Being an investor you will have the flexibility to choose between regular funds and tax-saving funds which are different from each other in terms of liquidity. Liquidity is when you can easily convert an asset into cash, open ended mutual fund is extremely liquid. Hence, you can easily sell these funds in case of an emergency. In case of equity funds, the redemption proceeds are available in T+2 days. Therefore, if you redeem from ABC Equity Fund on January 1, the amount will be credited to your account on January 3.
- Professional Portfolio Management: – Mutual Fund schemes are professionally managed by the fund managers. These fund managers are financial experts with years of stock market experience. Fund managers do a thorough research of stocks before making any investment decision. They also continuously monitor the portfolio to ensure optimum returns. Investing in mutual funds is easy. These funds are professionally managed by expert and experienced fund managers who have extensive experience in managing funds. Hence, even beginners who don’t have any knowledge about the market can invest in such funds with the help of expert managers. Since experienced professionals manage all activities related to these funds you can be assured that your money will be invested in safe places.
- Cost Efficient: – We all know that when you buy in bulk, the cost per unit comes down significantly. This is known as economies of scale. There are lakhs of investors in mutual fund schemes. So they are able to achieve economies of scale. This reduces the total expenditure of the fund. Since mutual funds offer SIP investment facility, the investors can start investing in these funds with as little as Rs.500 every month. When you opt for the Systematic Investment Plan (SIP) under a scheme you don’t have to invest thousands of rupees in the fund in one go. Instead, you can start your investment with a minimum of Rs.500 by opting for an SIP. Later, if you have a lump sum amount and feel the need to increase the invested amount you can invest more money in your fund.
- Perfect for Different Risk Profiles: – Not all mutual funds carry high risk. Liquid Mutual Funds invest in short-term government securities such as Treasury bills, certificates of deposit, etc. This makes Liquid Mutual Funds extremely safe. Liquid Mutual Funds are perfect for investors with low risk appetite for short term financial goals.
- Tax Benefit: – Tax benefit is another great advantage of mutual funds. ELSS fund is a special type of mutual fund which is specially designed to save tax. Investment up to ₹ 1.5 lakh in ELSS funds is eligible for deduction under section 80C of the Income Tax Act, 1961. Even debt funds offer the benefit of indexation when redeemed after 3 years. Equity mutual funds also offer tax benefits. Hence, when you invest in such tax-saving schemes you will get the benefit of not paying income tax for the amount of money that you have invested in the mutual fund scheme. In this way, such investments will bring down your taxable income.
- Easy to Track Funds: – It is not an easy task to regularly review the mutual fund investment portfolios as the fund units are purchased and liquidated by the subscribers on a regular basis. This is why the mutual fund companies provide clear statements of all investments thus making it easy for investors to keep a track of their investment. You can ask for the statement from the executives or can download it from the official website of the fund house that you have invested in.
What are the disadvantages of Mutual Funds?
The disadvantages of Mutual Funds are as follows: –
- High Cost: – There is no free lunch in this world. Similarly, mutual funds also come with cost in the form of expense ratio. The expense ratio includes fund management fees, marketing and selling costs, etc. A high expense ratio directly affects your portfolio returns. Investors who prefer low expense ratio can invest in ‘Index Funds’.
- Misuse of management authority: – Some fund managers may unnecessarily churn out portfolios. Portfolio churn is the continuous buying and selling of shares. Higher portfolio churn increases taxes and other costs. This reduces portfolio returns. Continuous churning can lead to poor investment decisions by your fund manager which can lead to huge losses.
- Come-in Period: – ELSS and FMP come with a fixed come-in period. They are highly liquid and cannot be used during emergencies. Ideally, mutual fund beginners should avoid FMPs. ELSS funds are a great tax saving option. But only those investors who can stay invested for at least 3 years should invest in ELSS funds.
- Exit Load: – Exit load is the penalty levied by the fund house on redemption before a specific period. Different types of funds have different exit load periods: –
- Liquid funds have an exit load period of 7 days.
- Debt funds have an exit load period of 30 days – 540 days (Credit Risk Debt Fund)
- Equity funds have an exit load period of 365 days.
- Over-Diversification: – Diversification is a double-edged sword. While it reduces the risk, it also reduces the profit earned by the investors. Sometimes fund managers invest in multiple asset classes. This is known as over-diversification. To avoid this, investors should make a goal-based financial plan before investing.