Advantages and disadvantages of investing in mutual funds

Published on April 12, 2023 | 6 min read

Before investing in mutual funds, you must know the advantages and disadvantages to make informed investment decisions.

Key Takeaways

Mutual funds are investment vehicles that pool money from many investors and invest it in equity or debt instruments to generate returns.
Investing in mutual funds can offer benefits such as professional management, risk diversification, liquidity, and affordability through low minimum investment amounts.
Mutual fund investments also carry certain disadvantages such as market-linked return volatility, lack of control over where your money is invested, recurring expense ratio fees, and exit loads charged for early redemptions in some mutual funds.
Before investing in a mutual fund, you should clearly identify your financial goals, risk appetite, and investment horizon to pick the right scheme.

According to a PIB press release, Indian households are rapidly shifting from traditional investments toward market-linked assets like mutual funds and equities, with average monthly SIP flows increasing sevenfold from under ₹4,000 crore in FY17 to over ₹28,000 crore in FY26.

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Let’s explore the advantages and disadvantages of investing in mutual funds so you can make informed investing decisions.

What Are Mutual Funds?

Mutual funds are investment vehicles that collect money from multiple investors to invest in equity and debt instruments based on a defined strategy. Mutual funds are launched by an Asset Management Company (AMC) and generally fall into two main structures — open-ended and closed-ended funds.

You can invest in different types of mutual funds such as equity, debt, and hybrid funds based on your risk tolerance and return expectations. These types are further subdivided into different categories.

When you invest in mutual funds, you are given mutual fund units, which represent your share in a fund, while NAV (Net Asset Value) is the per-unit value of the mutual fund and changes based on the value of its underlying investments.

Mutual fund investments are handled by professional fund managers, who use their market expertise to generate returns for the investors.

Advantages of Investing in Mutual Funds

The following are the advantages of investing in mutual funds in India.

Diversification

The money you invest in a mutual fund is invested across different companies and industries, diversifying your investment and helping lower concentration risk

Professional Management

Mutual fund portfolios are managed by expert fund managers who perform deep market research to buy and sell assets for you/on your behalf. . You do not need to monitor the market or spend time researching the right investment.

Low Cost and Affordability

Mutual funds offer an affordable approach to investing by allowing investors to start with relatively small, regular, and fixed amounts through SIPs (Systematic Investment Plans), instead of investing a lumpsum amount.

High Liquidity

Open-ended mutual funds are highly liquid, allowing you to buy or sell your mutual fund units smoothly, obeying the applicable scheme terms.

Tax Savings

Investing in certain mutual funds, such as Equity Linked Savings Schemes (ELSS), can offer tax benefits, allowing you to save on taxes under Section 123 of the Income-Tax Act, 2025.

Transparency

SEBI (Securities and Exchange Board of India) mandates fund houses to publish regular mutual fund reports and factsheets that disclose the fund’s holdings and performance, allowing investors to track their investments.

Disadvantages of Investing in Mutual Funds

The following are the disadvantages of investing in mutual funds.

Market Risk

Equity mutual funds are inherently volatile and fluctuate with the market. These funds offer no capital protection; your investment's value can drop significantly if the stock market faces a downturn.

No Guaranteed Returns

The mutual fund’s past performance does not guarantee good future returns and should not be used to predict subsequent performance. A fund that previously generated high returns can underperform or result in a loss in the future.

Expense Ratio

AMCs levy an expense ratio for managing your investments and cover administrative costs, which reduces your total mutual fund returns. Investors are advised to read the Scheme Information Document (SID) to know the expense ratio of the fund before investing.

Lack of Investment Control

Investors have no control or say over where their money is being invested since all investment decisions are made by the appointed fund managers.

Exit Loads and Lock-in Periods

Certain mutual funds may charge an exit load if you redeem your mutual fund units before a predefined period, which reduces your total return on investment.

Equity Linked Savings Scheme (ELSS) mutual funds have a mandatory 3-year lock-in period, which significantly reduces your liquidity.

Mutual funds are investment vehicles that pool money from many investors. This collected fund is then invested across different assets such as equity and debt instruments to generate returns for the investors. Investing in a mutual fund offers benefits such as diversification, professional management, high liquidity, the scope to invest with relatively small amounts through SIPs, and transparency.

Mutual fund investments also carry certain risks, such as market risk, expense ratio, lack of control over investments, no return guarantee, and lock-in periods. Investors must weigh both the advantages and disadvantages before investing to make informed decisions.

FAQs

What are the main advantages of mutual funds?

Mutual funds offer benefits such as diversification, professional management, and convenience. They also allow investors to start with relatively small amounts.

What are the disadvantages of mutual funds?

Mutual funds are subject to market risks, and returns are not guaranteed. Investors may also have to pay expenses such as an expense ratio and exit load, where applicable.

Are mutual funds safe?

Mutual funds are regulated investments, but they are not risk-free. The level of risk depends on the type of mutual fund and its underlying investments.

Do mutual funds guarantee returns?

No, mutual funds do not guarantee returns. The value of your investment can rise or fall depending on market conditions and the fund's performance.

Is investing in mutual funds better than keeping money in a savings account?

It depends on your financial goals and risk tolerance. Savings accounts offer easier access and relatively stable balances, while mutual funds can offer higher growth potential but carry market risk.

About Author

Mariyam Sara

Sub-Editor

holds an MBA in Finance and is a true Finance Fanatic. She writes extensively on all things finance whether it’s stock trading, personal finance, or insurance, chances are she’s covered it. When she’s not writing, she’s busy pursuing NISM certifications, experimenting with new baking recipes.