Advantages of Investing in Mutual Funds
1. Professional Management — Investors may not have the time or the required knowledge and resources to conduct their research and purchase individual stocks or bonds. A mutual fund is managed by full-time, professional money managers who have the expertise, experience and resources to actively buy, sell, and monitor investments. A fund manager continuously monitors investments and rebalances the portfolio accordingly to meet the scheme’s objectives. Portfolio management by professional fund managers is one of the most important advantages of a mutual fund.
2.Risk Diversification— Buying shares in a mutual fund is an easy way to diversify your investments across many securities and asset categories such as equity, debt and gold, which helps in spreading the risk – so you won’t have all your eggs in one basket. This proves to be beneficial when an underlying security of a given mutual fund scheme experiences market headwinds. With diversification, the risk associated with one asset class is countered by the others. Even if one investment in the portfolio decreases in value, other investments may not be impacted and may even increase in value. In other words, you don’t lose out on the entire value of your investment if a particular component of your portfolio goes through a turbulent period. Thus, risk diversification is one of the most prominent advantages of investing in mutual funds.
3. Affordability & Convenience (Invest Small Amounts) — For many investors, it could be more costly to directly purchase all of the individual securities held by a single mutual fund. By contrast, the minimum initial investments for most mutual funds are more affordable.
4. Liquidity — You can easily redeem (liquidate) units of open ended mutual fund schemes to meet your financial needs on any business day (when the stock markets and/or banks are open), so you have easy access to your money. Upon redemption, the redemption amount is credited in your bank account within one day to 3-4 days, depending upon the type of scheme e.g., in respect of Liquid Funds and Overnight Funds, the redemption amount is paid out the next business day.
However, please note that units of close-ended mutual fund schemes can be redeemed only on maturity. Likewise, units of ELSS have a 3-year lock-in period and can be liquidated only thereafter.
5.Low Cost — An important advantage of mutual funds is their low cost. Due to huge economies of scale, mutual funds schemes have a low expense ratio. Expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the fund’s daily net assets. Operating expenses of a scheme are administration, management, advertising related expenses, etc. The limits of expense ratio for various types of schemes has been specified under Regulation 52 of SEBI Mutual Fund Regulations, 1996.
6. Well-Regulated— Mutual Funds are regulated by the capital markets regulator, Securities and Exchange Board of India (SEBI) under SEBI (Mutual Funds) Regulations, 1996. SEBI has laid down stringent rules and regulations keeping investor protection, transparency with appropriate risk mitigation framework and fair valuation principles.
7. Tax Benefits —Investment in ELSS upto ₹1,50,000 qualifies for tax benefit under section 80C of the Income Tax Act, 1961. Mutual Fund investments when held for a longer term are tax efficient.
Myths & Facts about Mutual Funds
Myth : Mutual Funds are for experts
Fact : In fact, Mutual funds are meant for of common investors who may lack the knowledge or skill set to invest in securities market. Mutual Funds are professionally managed by expert Fund Managers after extensive market research for the benefit of investors. A mutual fund is an inexpensive way for investors to get a full-time professional fund manager to manage their money.
Myth : Mutual Fund investments are only for the long term
Fact : Mutual funds can be for the short term or for longer term based on one’s investment horizon and objective.
There are different types of mutual fund schemes – which invest in different types of securities – in equity as well as debt securities that are suitable for different investor needs.
In fact, there are various short-term schemes where you can invest for a few days to a few weeks to a few years e.g., Liquid Funds are low duration funds, with portfolio maturity of less than 91 days, while Ultra short-Term Bond Funds are low duration funds, with portfolio maturity of less than a year. There are Short-Term Bond Funds which are medium duration funds where the underlying portfolio maturity ranges from one year – three years. Then, there are Long-Term Income Funds which are medium to long duration funds with portfolio maturity between 3 and 10 years.
While Equity Schemes are most suitable for a longer term, debt mutual funds are suitable for investors with short term (less than 5 years) investment horizon.
Myth : Investing in mutual funds is the same as investing in stock market / Mutual Fund is an equity product
Fact : Mutual Funds invest in stock market (i.e., equities), bond market (corporate bonds as well as govt. bonds) and Money Market instruments such as Treasury Bills, Commercial Papers, Certificate of Deposit, Collateral Borrowing & Lending Obligation (CBLO) etc. Many of these instruments are not available to retail investors due to large ticket size of minimum order quantity (such as G-Secs) and hence, retail investors could participate in such investments through mutual fund schemes
Myth : Mutual Fund scheme with a NAV is Rs.10 per unit better than Mutual Fund scheme whose NAV is Rs. 25 per unit (Or a mutual fund scheme with lower NAV is better Or Investing in NFOs are preferable than investing in existing schemes).
Fact : This is a common misconception. A mutual fund’s NAV represents the market value of all its underlying investments. NAV of a fund is irrelevant, because it represents the market value of the fund’s investments and not the market price. Any capital appreciation will depend on the price movement of its underlying securities. Let us understand this through an illustration.
Suppose, you invest ₹10,000 each in scheme A whose NAV is ₹20 and scheme B (whose NAV is say, ₹100. You will be allotted 500 units of scheme A and 100 units of scheme B. Assuming that both schemes have invested their entire corpus in exactly same stocks and in the same proportions, if the underlying stocks collectively appreciate by 10%, the NAV of the two schemes should also rise by 10%, to ₹22 and ₹110, respectively. Thus, in both the scenarios, the value of your investment increases to ₹ 11,000.
Thus, the current NAV of a fund does not have any impact on the returns.
Myth : One needs a large amount of money to invest in Mutual Funds
Fact : Absolutely incorrect. One could start investing mutual funds with just ₹5000 for a lump-sum / one-time investment with no upper limit and ₹1000 towards subsequent / additional subscription in most of the mutual fund schemes. And for Equity linked Savings Schemes (ELSS), the minimum amount is as low as ₹ 500.
In fact, one could invest via Systematic Investment Plan ( SIP) with as little as ₹500 per month for as long as one wishes to.
Myth : One to have a Demat account to invest in Mutual Funds
Fact : Holding mutual fund Units in Demat mode is absolutely optional, except in respect of Exchange Traded Funds. For all other schemes, including the close-ended listed schemes like Fixed Maturity Plans (FMPs), it is entirely upto the investor whether to hold the units in a Demat mode or in conventional physical accountant statement mode.
Myth : A Scheme with a higher NAV has reached its peak!
Fact : This is a very common misconception because of the general association of Mutual Funds with shares. One needs to keep in mind that the NAV of a scheme is nothing but a reflection of the market value of the underlying shares held by the fund on any day. Mutual Funds invest in shares, which may be bought or sold whenever deemed appropriate by the Fund Manager depending on the scheme’s investment strategy (Buy-Hold-Sell). If the Fund Manager feels that a particular stock has peaked, he can choose to sell it.
A high NAV does not mean the fund is expensive. In fact, high NAV indicates a good performance of the scheme over the years.
Myth : Buying a top-rated mutual fund scheme ensures better returns.
Fact : Mutual fund ratings are dynamic and based on performance of the scheme over time – which in itself is subject to market fluctuations. So, a Mutual fund scheme that may be on top of the rating chart currently, may not necessarily maintain the same rating month after month or at a later date . However, a top rated fund is a good first step to short list a scheme to invest in (although past performance does not necessarily guarantee better returns in future). Investment in a mutual fund scheme needs to be tracked with respect to the scheme’s benchmark to evaluate its performance periodically to decide whether to stay invested or to exit.