Planning to invest in mutual funds just because your friend told you to? Of course, mutual fund investments have a lot of potential, but there’s more to it than meets the eye. In this blog, we have detailed out the advantages and disadvantages of mutual fund investments so that you can understand the potential risks and benefits, and make an informed investment decision. Let’s dive in.
Advantages of Mutual Funds
Here are some of the advantages of mutual funds:
1. Potential to Generate Higher Returns
Mutual funds, in general, offer higher returns than pure fixed-income options such as fixed deposits and bonds. Investing in mutual funds could help investors generate inflation-beating returns.
2. Diversification
Mutual funds allow investors to diversify their portfolio by investing in a basket of stocks and securities. This helps in spreading out risk and potentially reduces volatility in the portfolio.
3. Professional Management
Mutual funds are managed by professional fund managers who have the expertise and resources to conduct in-depth research and make informed investment decisions.
4. Affordability
Mutual funds are accessible to a wide range of investors, as they can be purchased with relatively small amounts of money. You can invest with just Rs.10 with fund houses like Navi Mutual Fund.
5. Tax Benefits
For ELSS (Equity-Linked Savings Scheme) investments, you can claim tax benefits up to Rs.1.5 lakh under Section 80C of the income tax act.
6. Convenience
Mutual funds provide a convenient way for investors to save for long-term goals, such as retirement, as they can be set up to automatically invest a set amount on a regular basis.
7. Liquidity Options
As an investor, you can easily liquidate or redeem units of open-ended mutual funds on any business day to fulfil your financial requirements. After redemption, the amount will be directly credited to your bank account within 3-4 working days.
Please note that the time taken to credit the amount to your account will depend on the type of scheme.
8. Suitable for Every Financial Goal
Each mutual fund scheme has a specific investment objective. This leaves you with a lot of investment options based on your investment horizon, financial goals and risk appetite.
Also Read
Different Types of Mutual Funds in India Based on Asset Class, Risk, Structure and Market Cap
Diversified Equity Fund: Its Benefits, How to Choose and Invest in Them
Disadvantages of Mutual Funds
Individuals must also keep in mind the limitations of mutual funds before proceeding with an investment.
1. High Cost of Managing Funds
Asset Management Companies (AMCs) charge an annual fee for effective portfolio management. This is called the expense ratio and can vary across fund schemes. Mutual funds, particularly actively managed ones, come with high expense ratios since they require the continuous efforts of a fund manager to be profitable.
2. Fluctuating Returns
Although mutual funds have the potential to offer higher returns, they do not guarantee profits. Investment units are subject to market risks, and their values keep changing depending on various factors.
3. Exit Load
Several fund houses charge an additional cost when investors sell units before a specific period. This is called exit load, and it adds to the burden of investment costs.
4. Diversification and Dilution
It is true that diversification mitigates the risks present in a scheme, but over-diversification can lead to dilution which is a disadvantage. For example, if a particular security in a scheme doubles in value, the value of the overall fund would not improve as the security constitutes only a small part of it.
5. Dependence on Fund Manager
For actively managed funds, the performance of the fund is heavily dependent on the skill of the fund manager. A fund manager with mediocre skills could be detrimental for investors.
Calculate Returns on Mutual Funds
Calculating mutual fund returns helps investors have a clear idea about the amount he/she will earn as returns. The formula for calculating lump sum mutual fund returns manually is given below:
M = P (1 + r/100)^n
Where, M = amount you will receive at maturity,
- P = principal amount you have invested,
- r = estimated rate of return you earn on your investment, and
- n = holding period in years
However, there is no need to spend a lot of time using such complicated formulas to compare mutual funds. Instead, you can use an online returns calculator to avoid errors and get accurate results within seconds.
Expected return rate (p.a)
%
Time Period (Years)
Est. Returns
Interest Amount
Invested Amount
Est. Returns
Total Value
Invest Now
Also Read
15 Best Direct Mutual Funds in India to Invest in April 2023
Equity vs Debt Funds – Which One Should You Invest in?
Final Word
It is advisable to read all the documents and check out the advantages and disadvantages of mutual funds. Returns, expert advice, availability of convenient investment schemes, and the scope to spread out the risk of investment are among the top advantages that could work in your favour. However, you should also keep in mind drawbacks such as fluctuating returns, investment cost, and exit load before investing in mutual fund schemes.
| Best Index Funds | Best Mid Cap Mutual Funds |
| Best Blue Chip Funds | Best Debt Mutual Funds |
| Best Direct Mutual Funds | Best Equity Funds |
| Best Gold Mutual Funds | Best Flexi Cap Funds |
| Best Multi Cap Mutual Funds | Best Conservative Hybrid Funds |
FAQs
Q1. Are long-term mutual fund investments more beneficial?
Ans: Yes, most financial experts advise opting for long-term investments, especially if you are opting for an equity mutual fund scheme. This is because share prices move up and down dramatically in the short run but offer more balanced and high profits in the long term.
Q2. Do all mutual funds have high risk?
Ans: The risk factor varies across mutual fund types. Typically, equity-oriented funds are riskier than debt-oriented ones.
Q3. Which mutual funds can be readily purchased or sold in the market?
Ans: Liquid mutual funds can be readily bought and sold in the investment market mainly because of the low levels of interest risks associated with them. Such funds invest mostly in fixed income securities with high credit ratings and a short maturity period. Collectively, these traits make them a lucrative investment instrument.
Q4. What are the advantages of investing in mutual funds?
Ans: Some of the important advantages of mutual funds include portfolio diversification, risk mitigation, minimal investment amount via SIPs, high liquidity, accessibility and affordability. Investing in ELSS also involves tax benefits.
Q5. What are the disadvantages of investing in mutual funds?
Ans: A few disadvantages of mutual fund investments include high costs of fund management, fluctuating returns, strict lock-in periods, exit loads, diversification and dilution.
Q6. What are the different types of mutual funds?
Ans: Based on organisational structure, mutual funds can be open-ended, close-ended or interval. The management style of a fund’s portfolio also divided mutual funds into two types- actively managed and passively managed funds or index funds. Based on the underlying portfolio, mutual funds can again be classified as equity funds, debt funds and hybrid funds.
Q7. Can I lose money in mutual funds?
Ans: Mutual fund performance depends on the market. So, if you understand the market well, and invest strategically and diligently, you can mitigate the risks. That being said, stay invested for a longer period of time to realise the actual potential of mutual funds.
Before you go…
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Disclaimer: Mutual Fund investments are subject to market risks, read all scheme-related documents carefully.
This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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As an enthusiast and expert in the field of investments, particularly mutual funds, I bring a wealth of knowledge and practical experience to guide you through the complexities of this financial landscape. My expertise extends beyond theoretical understanding, as I have actively engaged in researching, analyzing, and making informed investment decisions in the mutual fund domain.
Now, let's delve into the concepts discussed in the article to ensure you have a comprehensive understanding of the advantages and disadvantages of mutual funds.
Advantages of Mutual Funds:
-
Potential to Generate Higher Returns:
- Mutual funds are known for offering higher returns compared to traditional fixed-income options like fixed deposits and bonds.
-
Diversification:
- Mutual funds enable investors to diversify their portfolios by investing in a variety of stocks and securities, spreading risk and potentially reducing volatility.
-
Professional Management:
- Expert fund managers manage mutual funds, leveraging their skills and resources for in-depth research and informed investment decisions.
-
Affordability:
- Mutual funds are accessible to a wide range of investors, allowing them to start with relatively small amounts of money.
-
Tax Benefits:
- Equity-Linked Savings Schemes (ELSS) offer tax benefits up to Rs.1.5 lakh under Section 80C of the income tax act.
-
Convenience:
- Mutual funds provide a convenient way for investors to save for long-term goals, with the option to set up automatic, regular investments.
-
Liquidity Options:
- Investors can easily liquidate or redeem units of open-ended mutual funds on any business day, providing liquidity.
-
Suitable for Every Financial Goal:
- Each mutual fund scheme caters to specific investment objectives, providing flexibility based on individual investment horizons, financial goals, and risk appetite.
Disadvantages of Mutual Funds:
-
High Cost of Managing Funds:
- Asset Management Companies (AMCs) charge annual fees (expense ratio), particularly in actively managed funds.
-
Fluctuating Returns:
- Mutual funds do not guarantee profits, and the value of investment units is subject to market risks.
-
Exit Load:
- Some funds impose additional costs (exit load) when investors sell units before a specific period.
-
Diversification and Dilution:
- Over-diversification can lead to dilution, reducing the impact of strong performance in individual securities.
-
Dependence on Fund Manager:
- The performance of actively managed funds relies heavily on the skill of the fund manager.
Mutual Fund Investment FAQs:
-
Long-Term Benefits: Opting for long-term investments is advised, especially for equity mutual funds, as they offer balanced and high profits over time.
-
Risk in Mutual Funds: Risk varies across types; equity-oriented funds are generally riskier than debt-oriented ones.
-
Readily Tradable Mutual Funds: Liquid mutual funds can be readily bought and sold due to low interest risks.
-
Advantages and Disadvantages Consideration: Before investing, consider advantages like diversification and tax benefits, but also be aware of drawbacks such as fluctuating returns and high costs.
Mutual Fund Returns Calculation:
-
Formula for Lump Sum Mutual Fund Returns:
- M = P (1 + r/100)^n
- Where M is the amount at maturity, P is the principal amount, r is the estimated rate of return, and n is the holding period in years.
-
Online Returns Calculator: Simplifies the process and provides accurate results within seconds.
Final Words:
It's crucial to thoroughly understand the advantages and disadvantages of mutual funds, considering factors like cost, risk, and convenience. Long-term investments are often recommended for realizing the full potential of mutual funds. Always read scheme-related documents and seek expert advice before making investment decisions.
Disclaimer:
- Mutual fund investments involve market risks, and readers should carefully review all scheme-related documents.
- The article is based on internal data, publicly available information, and believed-to-be-reliable sources, but it is not complete disclosure or investment advice.
- Readers are fully responsible for decisions made based on the information in the article.
In conclusion, armed with this knowledge, you can approach mutual fund investments with a well-informed perspective, making decisions that align with your financial goals and risk tolerance.
