Advantages and Disadvantages of Mutual Funds
As an investor, you need to have adequate knowledge about the advantages and disadvantages of mutual funds. Once you know the good and the bad of investing in Mutual Funds, you can head-start even without having any experience. Comparing the pros and cons of every investment makes you a better investor; it’s your hard-earned money, after all.
What are the Advantages of Mutual Funds
There are lots of reasons to consider investing in the funds despite knowing the possible risks. Saving on taxes and low transaction charges are a couple of major advantages of investing in Mutual Funds. Some other possible benefits are:
1. Mutual Funds are Cost Efficient
Funds bought in bulk are cheaper than when you buy them in units. A mutual fund scheme has thousands of investors who can achieve economies of scale. Economies of scale refer to when you buy mutual funds in stock and save money on the purchase drastically. Doing so gets you two benefits, the overall expenses on funds reduces, and other unitholders share the equal amount of expenses, hence reducing the burden. When the expenses reduce, the return increases eventually.
2. Tax Savings is advantages
Investing in Multiple Mutual Fund allow the buyers the benefits of tax exemption or deduction. Mutual funds are relatively more tax-efficient than other types of investments. Also, if you invest in equity mutual funds, you can get tax-free returns in the form of zero long term capital gains. That means, if you sell your investment one year after purchase, you don’t have to pay tax or much of it is waived off.
3. Superior Diversification
Investing your money in mutual funds also helps you immediately gain access to a wider range of stocks that offer greater diversification than an individual investor’s portfolio. This advantage of investing in Mutual Funds reduces your exposure to a particular sector hence reducing the overall volatility of the investor’s portfolio.
4. Professional Portfolio Management
Like the share market, Mutual funds are also professionally managed by fund managers (brokers) who have years of experience in the financial market. The fund managers are responsible for managing investor’s portfolios with the help of a team of subject matter experts who help pick investments and strategize to maximize profits for the scheme’s investors.
5. Higher Liquidity
Higher Liquidity is one of the notable advantages of investing in the Mutual Funds market. Liquidity refers to the ability to convert assets and property into cash. Mutual Funds give you the freedom to retrieve the money quickly as per your needs. Moreover, a few fund management agencies also offer benefits such as instant redemption and debit card withdrawal of your mutual fund investment in case of financial emergencies.
What are the Disadvantages of Mutual Funds?
As said above, it’s always smart to do your own research before putting in anything be it Mutual Funds. On the downside, there are certain disadvantages of Mutual Funds. Here are the common ones you need to be well-prepared for.
1. High Cost
Mutual Funds also come with costs, sometimes the hidden ones in expense ratios, managing the funds, fund managers salary, distribution costs, etc. These costs can be substantial depending on the funds. You should also note that different funds have different expense ratios. Although the expense ratio covers fund management fees, marketing and sales costs etc., it directly affects your portfolio returns. Passively managed funds have lower expense ratios than actively managed funds because these track the underlying index and do not require a fund manager to take active investment calls.
Diversification reduces risk, but it also dilutes profits earned by investors. Sometimes, the fund managers invest in too many asset classes, which is also known as over-diversification. Over-diversification, there is going to be a little profit at your end. To avoid this, investors should do goal-based financial planning before investing. Since you should hardly have any second thoughts about investing in mutual funds, you still need to consider a few points to cover before investing in mutual funds.
3. Lock-in period is disadvantages
Some Mutual fund investments come with a lock-in period of three years, including the terms that you won’t be able to redeem the sum invested before the specified period. Whereas in other funds, you are expected to stay invested for a year. If you still choose to exit a fund before the lock-in period gets over, you will have to pay an amount as Exit Load. This also implies that you won’t be able to cash out in case of an emergency. This means, rather than investing in mutual funds; you can invest in Fixed Deposits.
4. Fluctuating returns
The returns on investment are never the same, which is the striking disadvantage of Mutual Funds. Mutual funds are subject to market risks (as you keep hearing again and again) and depend on the shifting trends in the market. There are no fixed returns in the mutual funds. Furthermore, the value of mutual funds may also fluctuate with time managed by the fund managers who keep complete track of the changing market trends. There is nothing in the investor’s control. On the other hand, if you invest in fixed deposits, the bank must follow the rules they agree upon while you deposit the amount. The positive side of a fixed deposit is, you’ll get the specified amount after the specified tenure.
5. Need for research
The disadvantages of Mutual Funds specified above somehow bring in the necessity of bearing expert-level knowledge. If you are a beginner without active portfolio management knowledge or how the system works, it’s better to have an expert to discuss the matter. You will probably fail to cope with the market fluctuations and, hence, make changes in your portfolio accordingly. Thus, it is recommended that you invest in mutual funds only with expertise.
The best way to invest is still a point where experts would come up with tons of opinions. The right way to invest in Mutual Funds is by observing the market trends. Contacting the experts comes next, depending on the factors influencing the bought mutual funds in the future. This concludes all major advantages and disadvantages of mutual funds. Special care must be taken when you have a limited source of income. It’s always a wise decision to invest with the smallest amount in such a case.