Advantages and disadvantages of mutual funds

Investing in mutual funds has gained significant traction over the years. If done right, mutual fund investments can help you build a significant corpus for various life goals. Like any other financial instrument, mutual funds have their share of advantages and disadvantages. Knowing them is essential to make intelligent decisions. Let’s take a look at both in detail.

Advantages of mutual funds

When you invest in mutual funds, you have the following advantages:

• Wide choice

When it comes to investing, choice matters, and mutual funds offer them in abundance. There are various types of mutual funds suited toevery investor category. You may go for equity funds if you have a high-risk tolerance and can withstand volatility. On the other hand, if you don’t want to take too much risk but want to preserve your capital, you can opt for debt funds.

If you want the best of both worlds, equity and debt, you can contemplate investing in hybrid funds. Even within the respective fund categories, there are different types of funds, each with a different asset allocation that you can choose from according to your financial goals, time and risk tolerance.

Professional management can make a significant difference, especially when it comes to your hard-earned money. Expert fund managers with years of experience manage mutual funds. After studying the markets, the fund manager and his team take calls on various buying/selling strategies, aligning them with the fund’s objectives.

During heightened market volatility, professional management helps funds cushion the gains and ensure gains remain protected. It also gives you peace of mind as your money is in the hands of experts.

• Start small

Mutual funds are for everyone. You don’t need a lot of money to kickstart investments in mutual funds. You can start investing with as little as ₹500 per month through systematic investment plans (SIPs). SIPs help you build wealth in a disciplined manner and ensure you remain invested across market cycles.

Investing even a small amount early on can help you accumulate a sizable corpus and benefit from the power of compounding. If you invest ₹500 monthly in an equity fund with an assumed 10% annualised return for 15 years, you can accruea corpus of over ₹2 lakh. If you increase the investment tenure to 20 and 30 years, the corpus swells to ₹3.8 lakh and ₹11.3 lakh respectively. However, the actual corpus you accrue will depend on the chosen fund’s performance.

• Offers diversification

Diversification is one of the fundamental investing principles. It ensures your money is spread across asset classes, sectors and industries. Mutual funds help you diversify seamlessly. The underlying portfolio of diversified mutual funds consists of stocks from different companies across industry verticals. It ensures the fund’s returns are not dependent on the performance of any one stock.

By investing in two to three different types of mutual funds, you can get exposure to stocks of different companies. Optimum diversification stabilises your portfolio in the long run and helps in effective risk mitigation.

• Liquidity

Liquidity means how quickly you can convert your investments into cash. Mutual funds are highly liquid. Upon placing a redemption request, the money is credited into your account within 1-2 business days, so you can quickly access your money in case of any emergency.

Mutual fund disadvantages

While mutual funds have several advantages, they have certain drawbacks, too. Some of the common disadvantages of mutual funds are as follows:

• Market-linked products

Mutual fund investments carry market risks. Their returns aren’t guaranteed and depend on various micro and macroeconomic factors. Even debt funds, which have relatively less risk than equity funds, are not entirely risk-free. Mutual funds may not suit you if you want assured investment returns.

• Past performance doesn’t guarantee future results

If a fund has performed well in the past, it doesn’t mean it will continue to do well. Therefore, you shouldn’t invest in a mutual fund going by its past performance. You must look at a fund’s long-term track record, preferably over 7 to 8 years, analyse the consistency of returns, and then invest.

• AMC’s view not in alignment with individual

The views and strategies of the AMC managing the fund may not align with individuals. For example, if an individual's risk tolerance or investment objective is different from the AMC's approach, it may lead to suboptimal returns. Conflicting viewpoints may also lead to dissatisfaction among investors who may feel that their preferences and goals are not adequately reflected in the fund's strategy.

• No control over cost

This is another major disadvantage. Unlike direct stock investment, where you have control over the cost of your investments, mutual funds have no such thing. It varies across AMCs. You need to pay various fees and expenses that can affect your returns. Also, the fund manager makes all major decisions related to fund management, and you have no say in them.

Summing it up

The advantages of mutual funds outweigh their disadvantages. Investing in a fund aligning with your financial goal and risk tolerance can derive optimum results from your investment. Mutual funds, especially equity and hybrid funds, are long-term products; therefore, you must remain committed to your investments and avoid knee-jerk reactions following market volatility. Analyse your portfolio once every six months to see the performance of your assets.

Disclaimer: This article is for informational purposes only and does not constitute financial advice. Investors should conduct their own research and consult with financial professionals before making any investment decisions.