Mutual funds are a popular long-term investment option among Indian investors. Risk diversification and reduction, professional portfolio management and trade convenience are just a few of the many advantages that draw Indians towards mutual funds . In fact, in the last five years alone, the assets under management (AUM) of the mutual fund industry in India has doubled, from ₹22.86 trillion in June 2018 to ₹44.39 trillion in June 2023.
However, mutual funds also have some disadvantages that one must be mindful of when investing. In this article, we will discuss both theadvantages and disadvantages of mutual funds in India.
Let’s begin by understanding what are mutual funds.
What are mutual funds?
Mutual funds are a collective investment vehicle that pools investor money and invests it in stocks, bonds, government securities and money market instruments. This investment portfolio is managed by professional fund managers whose primary objective is to earn capital gains or income for investors. Each investor participates in the gains and losses of the fund proportionally.
Mutual funds are divided into different categories based on different factors like the type of securities they invest in, the type of returns they expect and their overall objective.
Now that we know what mutual funds are, let’s look at their advantages and disadvantages.
Advantages of mutual funds in India
There are several reasons why Indian households invest in mutual funds. Below are a few advantages of mutual funds:
-
Low entry barrier
One does not need a fortune to invest in mutual funds. You can start investing via a systematic investment plan (SIP) with as little as ₹500 per month. In fact, mutual funds are ideal investments for investors who are new to the market, or do not have the time to track markets on a daily basis or wish to invest small amounts only.
-
Cost averaging
This factor comes into play when you invest in mutual funds via the SIP route. The markets can be volatile, but when you invest via an SIP, you invest the same amount on a monthly basis irrespective of market conditions. Thus, you end up buying more units when markets are down and fewer units when the markets are up. In the long run (i.e. five years and more), the average cost you pay per unit will decrease. Hence, market volatility has minimal impact on your investments and it also helps you leverage the benefits of compounding.
-
Compounding
Put simply, this is where your ‘returns earn returns’ and is one of the most effective ways to create wealth. Say you invest ₹100 in a mutual fund and it gives you a 5% return. This means your investment is now worth ₹105. If you stay put and allow the returns also to be reinvested, you will earn returns on ₹105 in the next year. How much you invest and how long you stay invested will determine the returns you earn.
-
Diversification
Diversification helps reduce the risk in a portfolio. Put simply, you invest your money across asset classes or securities. This way, if one asset delivers negative returns, the returns from other assets helps cushion the loss. You can diversify your mutual fund portfolio by investing across different asset classes, sectors or securities, such as gold, index funds, equity and debt. Some fund houses also offer diversified funds. Use these judiciously to reduce your risk.
-
Professional portfolio management
Asset management companies (AMC) hire professionals with the knowledge and skill required to monitor various investment opportunities actively. They study and understand the market to identify investments they can buy/sell to maximise your profit. The expense ratio that you pay is used to pay the fund managers and research teams that manage your money.
-
Tax benefit
Equity linked savings schemes (ELSS) are a special category of mutual funds that offer market-linked returns along with tax benefits. Under section 80C of the Income Tax Act, investment up to ₹1,50,000 in ELSS (Equity Linked Savings Scheme) is exempt from income tax.
-
Transparency
The Securities and Exchange Board of India (SEBI) regulates mutual funds, making it mandatory for them to disclose the manager's qualifications, stock value, fund performance, the track record of the fund house and fund manager and most importantly, the risk profile of the investments made by the fund. Funds also have to mandatorily disclose the net asset value (NAV) on a daily basis. All this helps ensure transparency for investors.
Disadvantages of mutual funds in India
While the advantages of mutual funds make them sound lucrative, they have their share of disadvantages too. Listed below are some of them.
-
Lack of control
Fund managers and analysts hired by the AMC control, monitor and take all major decisions, leaving investors with no control over the investment. Having said that, you can study the AMC's investment strategy, disclosure policies and other parameters before investing in mutual funds.
-
Diversification
Indeed, diversification helps reduce the overall risk associated with mutual fund investments. However, the reduced possibility of losses also indicates diminishing chances of making significant profits.
-
High expense ratio
The expense ratio is the cost per unit that an AMC charges for managing a fund. If the expense ratio crosses 1.50%, it is regarded as high. A high expense ratio indicates a lower return on your investment.
Before investing, you must also know that some AMCs may demand additional charges apart from the management and annual fee. These include sales charges, distribution fees (advertising and promotional charges) and entry and exit loads.
-
Evaluation
Fund evaluation may get complicated for investors. Once they have invested in a mutual fund, they may find it challenging to study parameters like standard deviation, alpha or Sharpe's ratio. This further makes it difficult for investors to determine the performance of one fund against another.
-
Unpredictable returns
Market conditions and fluctuations heavily influence returns. Even professional management does not safeguard or insulate you from the bad performance of the fund you have invested in. Hence, before investing, you must understand the fund's risk profile.
In conclusion, the advantages offered by mutual funds far outweigh their disadvantages. Do your research, identify your risk appetite, define your investment goals and shortlist funds that align with them. Use accepted industry metrics to compare funds.
And if all this seems like too much, click here to check out the ‘Invest’ section on the Upstox app. We have done all the hard work for you and made a list of top-rated funds across categories. All you need to do is invest!
Disclaimer
The investment options and stocks mentioned here are not recommendations. Please go through your own due diligence and conduct thorough research before investing. Investment in the securities market is subject to market risks. Please read the Risk Disclosure documents carefully before investing. Past performance of instruments/securities does not indicate their future performance. Due to the price fluctuation risk and the market risk, there is no guarantee that your personal investment objectives will be achieved.