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10 Advantages of Mutual Funds:

Let us first look at the advantages of mutual funds:

1. Diversification

To diversify is to reduce risk. For example, let’s say you buy milk from one milkman. If
someday he falls ill, you won’t have any milk to drink! On the other hand, let’s say you buy
milk from two milkmen. If one milkman falls ill, you’ll still have milk from the other milkman.
The chance of both the milkmen falling ill at the same time is very low. This is why
diversification is so important in investing.

Investing requires in depth research and analysis which usually takes a long period of time.
Often, people do not have so much time. Mutual funds are managed by fund managers who
invest money in a manner that allows diversification.

The advantage of mutual funds is that diversification is automatically done. Instead of

2. Professional Management

Investing is obviously not an easy task. Investing, be it in shares, real estate, gold, bonds,
and so on depends on a multitude of factors that constantly need to be studied and
understood. Many people often think they can understand the markets. A great percentage
of these people end up making losses.The advantage of mutual funds is that they are
managed by qualified and professional experts. Thus, to ensure your money is invested in
the right places, you only have to choose the right mutual fund. That is much easier than
constantly monitoring investments. Once invested in a mutual fund, you can relax with the
knowledge that an expert will make necessary changes to the portfolio whenever
required.This isn’t to say that you shouldn’t review your investments in mutual funds.

3. Simplicity
When investing, the availability of information and data is particularly time-consuming. If all
information would be easily available, investing would be much simpler.Investing in mutual
funds is much easier and simpler. The research and information collection is done by the
mutual funds themselves. All you have to do then is analyse the performance of mutual
funds.Mutual fund dealers allow you to compare the funds based on metrics such as level of
risk, return, and price. Because the information is easily accessible, you, the investor, is able
to make wise decisions.

4. Liquidity

Of all others, one of the advantages of mutual funds that is often overlooked is liquidity. In
financial jargon, liquidity basically refers to the ability of being able to convert your assets to
cash with relative ease. Consider this: if you own a house and need cash, how long would it
take for you to sell the house and get cash in hand? It could take anywhere from a few
weeks to a few months. Mutual funds are considered liquid assets since there is high
demand for many of the funds in the marketplace. Since this is the case, you can retrieve
money from a mutual fund very quickly. Usually, in about two days.

5. Costs

Mutual funds are one of the best investment options considering the costs involved. If you
hire a portfolio management service, you’ll typically be charged 2% to 3% of your total
investments per year. They will also take a share from your profits.Mutual funds are
relatively cheaper with 1% to 2% of expense ratios. Debts funds have an even lesser
expense. Read more about expense ratio:

6. Tax Efficiency
Mutual funds are relatively more tax-efficient than other types of investments. Long-term
capital gain tax on equity mutual funds is zero. That means if you sell your investments one
year after purchase, you pay no tax.For debt funds, long-term capital gains apply when you
hold them for 3 years. Understand tax on mutual funds:Apart from this, there are a certain
class of funds, called ELSS funds, that are exempt under section 80c up to a limit of Rs 1.5L.
Some important features of tax saving funds:

1. Surrogate route to direct stock markets

7. Selection of Mutual Funds:- Mutual Funds come with different types – this allows
investors to invest in particular type depending on your goals. Depending on you goals, you
can choose the appropriate category to invest in. Here are some examples

1. For parking money for very short term, you can invest in liquid funds like Kotak
Floater Short Term
2. For investing for short-term duration like 1 to 3 years, you can invest in Ultra Short
Term Funds (example – Franklin India Low Duration Fund) or Short Term Funds
(example – HDFC Short Term Opportunities Fund)
3. For Tax saving, there are tax saving funds as we discussed in the previous section.
4. For Long-term investing there are equity funds. In equity funds also, one can choose
from high-risk funds like mid cap and small cap funds to relatively less risky funds like
large cap and diversified funds
5. For people who want to take a middle approach, there are balanced funds. Example
– HDFC Balanced Fund.
8. You can start with very small amounts

Unlike other investments like real estate or investing directly in stocks, mutual funds allow
you to start as small as Rs 500. One can start with mutual funds with as low as Rs 500 or Rs
1000. Some funds, like Reliance Small Cap Fund allow you to start with just Rs 100.

9. Automated investments

Because of our human behaviour, we can easily fall prey to our laziness or emotions (fear
and greed). Mutual funds allow us to set automated investing to make way. One can start
automated investments in mutual funds with any paperwork.

10. Safe and transparent

Investing in mutual funds is very transparent. All mutual funds companies come under the
purview of SEBI and they need to make necessary disclosures. All the stocks they hold are
known to you. The historical performance is all out in public. Fund managers qualification
and track record are known. The NAV (net asset value) of the fund is updated every day. On
any mutual fund page on Grow – you can look at all the details about the mutual fund.

Mutual funds investments are also very safe as the transaction happens in a very
transparent way. Also when you redeem, money goes directly into your bank account,
hence no chance of someone hacking into your account.

11. Option to choose SIP or Lump sum

Mutual funds also give you the flexibility to invest through SIP (systematic investment plan)
or through lump sum.
12. Match Your Style

If you have more knowledge about certain industries or sectors, but don’t have enough
expertise to know which companies to invest in, you can make use of sector mutual funds.
By doing so, you are ensuring your money gets invested in a certain industry without having
to research which companies to invest in.

Sector mutual funds stick to investing primarily in a certain sector only. Some common types
of sector mutual funds are mining funds, energy funds, automobile funds, etc.

1.11 Disadvantages of Mutual Funds:

And now, the disadvantages of mutual funds:

1. Costs

Surprised to see “Costs” in both advantages and disadvantages of mutual funds?

Some mutual funds have a high cost associated with them. Mutual funds charge for
managing the funds, fund managers salary, distribution costs etc. Depending on the fund,
these charges can be significant. When you exit from your mutual fund, you might be
charged an extra cost as exit load. Do check out exit loads before investing in a fund.
Typically, exit loads are applicable if you sell your investments within a specified duration.

Investors should note that different funds have different expense ratios. Passively managed
funds like index funds or ETFs (Exchange Traded Funds) have lower expense ratios than
actively managed funds. This is only because passively managed funds track the underlying
index and do not require a fund manager to take active investment calls.
Lower costs reflect the operational efficiency of a mutual fund house. All the other factors
remaining the same, an investor should ideally invest in a scheme which charges a lower
expense ratio compared to peers as higher expenses reduce returns of the fund.

2. Dilution

This is one of the most prominent of all disadvantages of mutual funds. Diversification has
an averaging effect on your investments. While diversification saves you from suffering any
major losses, it also prevents you from making any major gains! Thus, major gains get
diluted.

This is exactly why it is recommended that you do not invest in too many mutual funds.
Mutual funds are themselves diversifying investments. Therefore buying many mutual funds
in the name of diversifying only further dilutes your gains.