Advantages and Disadvantages of Investing in Mutual Fund

Advantages and Disadvantages of Investing in Mutual Fund

Mutual funds combine the best of returns enhancement and risk management, which is why they are good long term wealth creators. Mutual fund returns provide the market edge with the hybrid flavour of balanced advantage funds. Today, investors have a choice of over 2,000 mutual fund schemes on offer across more than 40 fund houses on offer and it is a problem of choice more than anything else for the investors.

There are several advantages of mutual funds like professional management, diversification and choice. There is the additional mutual fund tax benefit that is not only in the form of the more efficient capital gains treatment but also of benefits in special funds like the ELSS funds. Of course, quite often the mutual fund performance tends to be volatile and erratic, which is one of the disadvantages of mutual funds. However, over the medium to long term, the mutual funds are one of the finest financial planning products.

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Here are some key advantages of investing in mutual funds

Some of the advantages that mutual funds offer are simply indisputable. Sample these.

a) Mutual funds outperform other asset classes over a longer time period due to the advantage of professional management. This is true for equity funds and also of debt funds. The professional management also acts as a risk mitigator.

b) One of the big advantages of mutual funds is that they spread your money across asset classes and asset grades. There is a natural diversification built into mutual funds that you can never manage directly. This reduces the risk for the investor substantially.

c) Other than ELSS Funds that are locked in for 3 years, all other categories of mutual funds are liquid and can be redeemed at market levels. Price risk is there, but you can encash debt funds and liquid funds in a day while equity funds can be encashed in a couple of days. This is especially true of open ended mutual funds.

d) Mutual funds can be cost effective due to scale. The cost of the fund is spread across thousands of investors and hence the per unit cost is small and investors are able to make reasonable returns even after considering these costs.

e) Mutual funds offer a solution for every need and every goal. There are equity funds for growth, debt funds for stability, liquid funds for liquidity, gold funds for alternate asset classes and the list can go on. This feature makes mutual funds the best instruments for financial planning.

f) Mutual funds bring professional edge to the table that individual investors can never manage on their own. In-depth research into stocks, dealing finesse, market intelligence, access to assets, passive approach etc are some of the advantages of professional management that accrue to small investors at a very nominal cost.

g) Since mutual returns are normally in the form of capital gains, they are tax efficient. Also ELSS Funds offer the added edge under Section 80C of the Income Tax Act.

h) Finally, mutual funds are convenient and open to all. You can do the complete MF transacting online and you do SIPs with as little as Rs500 per month.

Key Disadvantages of Mutual Funds

However, there are also some challenges that mutual funds come with.

a) The overall cost, especially for regular plans, can be quite high. These include fund management fees, marketing and sales costs, dealing and audit costs, manpower costs etc. The high expense ratio impacts portfolio returns. Exit loads add to these costs.

b) There have been several instances of mutual fund managers not acting in the interest of the investors. For example, fund managers may churn stocks too often, they may indulge in front running and may not try for the best deal for unit holders.

c) In some of the funds like ELSS and FMPs, the lock-in period can hamper liquidity. This is also true of most closed ended funds. 

In totality, MFs have emerged as a product with several unique merits to its credit that far outweigh the handful of disadvantages in this product.