Some will say let it earn interest in a savings account or a fixed deposit. It may sound like a good idea, but the rate of inflation is much higher than what banks provide as interest, so you will still lose money. The last remaining resort is investment. When you invest your money in mutual funds or stocks, the potential to counter inflation is high because the returns are good. But, as with any other investment, it is of utmost importance to understand everything about mutual fund risk and return. But before we weigh in the pros and cons of mutual fund investment, let us first understand what a mutual fund means.
What is a mutual fund?In the most basic terms, a mutual fund is a collection of money that is pooled together from many investors. Once a significant corpus is generated, it is invested in various types of securities like stocks, debt funds and fixed income securities. Mutual funds are managed by an Asset Management Company or AMC who employ professional experts or money managers to handle mutual funds. In the case of stock market investment, you have to buy shares of a company directly via the stock market. On the other hand, in mutual funds, you buy part of a mutual fund, which is invested not only in stocks, but also in other portfolios.
When the funds are invested in many different portfolios, the risk of depreciation is low because of the power of diversification. This makes mutual funds one of the low risk investment options. Also, mutual funds are more beneficial over stocks because it is up to the experts to decide where to invest the funds based on changing market trends. The primary goal of these money managers is to make sure that the investors receive good returns.
What are the benefits of investing in mutual funds?Mutual funds have steadily become one of the most popular forms of investment option. And the reason is simple. It is because investing in mutual funds carries with it plenty of advantages and benefits, especially when directly compared to stocks. Let us take a look at the many mutual fund benefits below.
DiversificationWhen it comes to mutual funds, the term diversification means that the pooled amount of invested money is not invested in a singular financial instrument. It is divided and invested in many different securities that include equity or shares, debt funds and money market instruments. The logic behind this is that there is very little chance of all these instruments failing at the same time. When one of these is failing and giving low returns, others may increase and give higher returns, thus balancing each other out. This ensures that the invested money is much safer, which is unlike stocks, where you may lose your entire investment because it was put in to buy shares of one company, which is not doing well.
Professional managementMutual funds are monitored and managed by professional money managers. They are responsible for deciding when and where to invest the mutual fund by closely following market trends and doing research. Investment, whether it is mutual funds or stocks, is quite an exhaustive process which requires a good understanding of the financial market and great skill. When it comes to mutual funds, all the hard work is done by these money managers, who are professional experts that are well equipped with all the tools that are required to manage the mutual funds. Therefore, you can rest assured that your money is in good hands.
LiquidityThe term liquidity means the ability of an asset to be converted into liquid cash. The money you have in your bank account is purely liquid, because you can instantly withdraw it whenever you want. If you have some gold saved, it is not yet liquid, but it can be converted to cash by selling it quite easily. On the other hand, something like your home or your car, is not a liquid asset. When you want to sell it for cash, it could take weeks for the transaction to take place. In this regard, a mutual fund investment is a highly liquid asset, which means you can easily convert it to cash when required. Of course, this depends on the type of mutual fund. Enquire about conditions for selling your mutual fund units before you invest.
Smaller investments an optionUnlike stocks and real estate, which require particularly large investments in order to get feasible returns, mutual fund investments can be done with as little as Rs 500. What’s more, there is also the option of Systematic Investment Planning or SIP, which allows you to make small investments on a monthly basis, for as long as you like. This is one of the biggest advantages of mutual fund investment, because people from all strata of society can invest according to their capabilities with great ease.
Convenience and simplicityInvesting in the stock market can be quite a complicated affair. Unlike the stock market, mutual fund investment is as simple as it can get. You can approach any bank or Non-banking financial company and get your mutual fund investment going instantly. All you will require are some basic Know Your Customer (KYC) documents and you are good to go.
Risks associated with mutual fund investmentsWhen it comes to investment opportunities, it is very important to study the risks that come with it, along with the benefits. Though not as risky as stock market investment, mutual fund investments do have certain risks and disadvantages associated with them. A mutual fund risk is anything that can make the fund value go down, or decrease your eventual profits. Read on to know the risk of investing in mutual funds.
Dilution or over-diversificationYes, diversification of investment is considered an advantage of mutual funds. But too much of anything is always counterproductive. Diversification is a tool that makes sure that by investing in many funds at the same time, your losses are limited. However, investing in too many mutual funds and over-diversifying is a major risk of mutual funds investment and will lead to dilution of the returns. For the sake of lowering the losses, you also risk reducing your profits.
ChargesThere are some costs and charges associated with mutual fund investments. When you invest your money in mutual funds, a small percentage of it will go towards the salaries of the fund managers and market analysts since they are doing the major heavy lifting. This is unlike stock market investment, where you can directly invest in stocks without a middle man. Furthermore, there is an entry load you have to pay when you start a mutual fund. Also, some mutual funds have a lock in period, and if you sell your fund before time, you will be charged an exit load fee. These extra expenses can be one of the main disadvantages of a mutual fund investment.
No controlWhen you buy a mutual fund, you ultimately give complete control of your funds to the money managers who are handling your funds. Of course, due to their expertise, they may be in a better position to manage the mutual fund. But even then, you will have more or less no control of your funds. You will be able to keep an eye on your fund performance and the strategy of the financial analysts, but nothing more.
Fluctuations of fund performanceEven though mutual funds are considered less risky than stocks, their performance is still prone to fluctuations. Because a significant portion of mutual funds are invested in equity, even with the diversification aspect, your mutual fund value may depreciate after some years. This is irrespective of whether your professional money managing team is very experienced or not. Because this sort of fluctuation is dependent on market trends, which can be unpredictable.
Thus, mutual fund investments have both advantages as well as disadvantages. But, this article makes it obvious that the pros of mutual fund investment far outweigh their cons. As an investment option, a mutual fund is one of the safest options out there. You can either go for a lump sum investment or start a Systematic Investment Plan of monthly investment amounts that you consider suitable. However, it is important to take mutual fund risk measures carefully before investing. A mutual fund risk calculator is available on many finance websites. It will help you find out the risk associated with mutual fund investments.
Explore Various Mutual Funds here.
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
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