Advantages of Mutual Funds

Introduction

A mutual fund is an investment avenue that pools money from various investors. The fund is managed professionally, usually by an asset management company and is used to buy other well-performing securities, typically bonds and stocks.

Among the plethora of benefits of investing in mutual funds, some of them are
●    Direct mutual fund investments at zero commission
●    Professional management 
●    Risk reduction via diversification
●    Liquidity transparency
●    Flexibility 

and a large range of options to choose from. 

With 5paisa, an investor can use the 5paisa mobile trading app to easily invest in mutual funds by completing the necessary registration steps. This article provides a comprehensive overview of the advantages and disadvantages of mutual funds.
 

What are Mutual Funds?

Mutual funds are a prevalent investment choice amongst investors globally. It is an investment vehicle that pools funds or assets from shareholders to further invest in securities like money market instruments, bonds, stocks, and other assets. 

One of the benefits of mutual funds is that they are professionally managed by money managers who produce capital gains or returns for investors by allocating the fund's assets. Fund managers who manage mutual funds invest in many securities and track their performance. They are also referred to as investment advisers, who are legally obligated to work in the interest of the shareholders of the mutual funds. The portfolio is structured and maintained to meet the investment objectives as stated in the fund’s prospectus. 

Small and individual investors get access to professionally managed equity and bond portfolios by investing in mutual funds. All investors thus become shareholders in the fund’s performance and participate proportionally in the gains and losses of the fund.

The pricing of the mutual fund depends on the performance of the securities in the fund. When investors purchase a unit of a mutual fund, they buy into the portfolio's performance. Investing in the shares of a stock is very different from investing in a unit of a mutual fund. Unlike shares of stock, mutual funds do not come with voting rights for their holders. A mutual fund share represents the investment in multiple stocks or other securities.

The net asset value (NAV) per share is also expressed as NAVPS is the price of a share of a mutual fund. You can calculate it by dividing the total value of the portfolio securities by the total number of outstanding shares, which are held by all institutional investors, the company officers, and the shareholders.

Shares or units of a mutual fund can be purchased or redeemed by the shareholder at the current NAV of the fund, which does not vary during the market hours but is fixed or settled at the closing of each trading day.

One of the other benefits of mutual funds is that a mutual fund's shareholders diversify their investments as an average mutual fund tends to hold other securities. Holding different securities allows the mutual fund to offset the gains or losses from one stock with the losses and gains from stocks of other companies.

Advantages & Benefits of Mutual Funds

There are multiple reasons why mutual funds are an extremely popular choice for many people across the globe.

One of the top benefits of mutual funds is Diversification. It mixes various assets or investments within an investor’s portfolio to reduce risk. A well-diversified portfolio has securities from different industries and capitalization. Such a portfolio also comprises bonds from various issuers and varying maturities. By investing in mutual funds, investors can achieve diversification of investments in a cheaper and faster manner in contrast to buying individual assets and securities.

Another benefit of mutual funds is the ease of access with which the securities can be bought and sold on major stock exchanges, making them a highly liquid choice for investment. For certain assets, such as exotic commodities or foreign equities, mutual funds are typically the most feasible option for individual investors.

By investing in mutual funds, an investor achieves economies of scale by foregoing multiple commission charges that may otherwise be needed to create a diversified portfolio. Investing in only one security at a time may result in very high transaction fees. Purchasing smaller denominations of mutual funds allows investors to take advantage of the dollar-cost averaging or rupee-cost averaging benefit.

As mutual funds tend to buy and sell a larger number of securities at a time, they tend to have lower transaction costs than what an individual investor would otherwise pay for purchasing or selling security transactions. A mutual fund can also invest in certain specific assets and securities or take a larger position than what would be possible for the individual and smaller investor.

Investment managers professionally manage mutual funds. Professional investment managers use careful research and skilful trading to manage their fund portfolios. Additional benefits of mutual funds in India are that they can inexpensively leverage a professional investment manager’s expertise to monitor, make and manage their investments full-time. As mutual funds require a much lower investment minimum, investing in them is a low-cost approach for individual investors to experience and draw advantage of the skills of professional money managers.

Mutual funds also allow investors to research and select from various management goals using different management styles.  A mutual fund manager may focus on value investing, growth investing, emerging or developed markets, and incoming or macroeconomic investing, among many other styles.

Another benefit of mutual funds in India is the range of options in specialized mutual funds allows investors to gain exposure, to not stocks and bonds alone, but also to different commodities, such as foreign assets, real estate, etc. Ordinary investors also get a chance to invest in foreign and domestic investment opportunities that may otherwise not be accessible to them by investing in mutual funds.

Mutual fund investments are also subject to multiple industry regulations that ensure accountability and fairness to all investors, accounting for the transparency of mutual fund investments.

Disadvantages of Investing in Mutual Funds

The many advantages, such as high liquidity, diversification and expertise, and professional management skills, make mutual funds attractive and the preferred choice of investment vehicle. However, mutual funds have certain drawbacks.

The first is the lack of guarantees. Like many other investments without a return guarantee, there is always a possibility that the value of mutual funds might depreciate. Equity mutual funds may be prone to experiencing fluctuations in price, in addition to the stocks in the mutual fund's portfolio.

A large and significant chunk of the mutual fund portfolio is to be held in cash to satisfy the share redemption requirements each day. To maintain liquidity and the capacity to accommodate any withdrawals, mutual funds tend to have a large portion of their portfolio as cash. This portfolio is termed cash drag, as the cash tends to earn no return.

As mutual funds provide individual investors with professional and expert management of the fund’s portfolio, the fee reduces the fund’s overall payout. As the fees may vary from fund to fund, not paying attention to the associated fees of a mutual fund can have a negative consequence in the long term, as actively managed funds may incur a transaction cost that can accumulate over each year.

Steps to Invest in Mutual Funds through 5paisa

The process of investing in mutual funds through 5paisa is fairly simple:

1.    Login into your 5paisa account. Creating a new 5paisa account is simple and can be completed in 3 easy steps.
2.    Once logged in, search for a mutual fund scheme of preference or simply explore “All Mutual Funds”.
3.    Simply select a mutual fund scheme that best meets the investor’s criteria and requirements.
4.    Choose your preference of investment type- either through SIPs or via a lump sum.
5.    After all steps are completed, the final step is for the investor to proceed with payment.

Frequently Asked Questions

Q.1: What is the minimum amount that you can invest in mutual funds?

Ans: Depending on the mutual fund, certain funds offer SIPs for as low as ₹100. The majorly accepted general practice is for funds to insist on ₹500 as the minimum amount for investments through SIP.

Q.2: Are mutual funds tax-free?

Ans: Not all mutual funds qualify for tax deductions under Section 80C of the Income-tax Act.  However, investments under the equity-linked saving scheme commonly referred to as ELSS do qualify for tax deduction under section 80C. Investors investing in ELSS can claim deductions of up to ₹1.5 Lakhs under section 80C of the Income-tax Act.

Dividends paid by the equity mutual funds are free of tax for the investor, although the AMC pays the DDT or the Dividend Distribution Tax at 11.648%. The minimum holding period for short-term capital gains in debt funds is three years for debt mutual funds.

Q3: What are the different types of mutual funds in India?

Ans: There are many mutual funds available for investment, typically and commonly available under four main categories: stock funds, money market funds, bond funds, and target date funds. 

Stock funds typically invest in equity or stocks. Bond funds are often actively managed and seek to buy undervalued bonds to sell them at a profit. Index funds, balanced funds, money market funds and income funds, international/global funds, and speciality funds are some other types of mutual funds available in India.