Advantages and Disadvantages of Mutual Funds: Things to Keep in Mind while Investing

Mutual Funds

“Lights, camera, action!” Whenever we watch a movie, we are captivated by the director’s vision, the actors’ performances, the cinematographer’s view. But, how often do we recognize the role of a producer who funds the movie, ensuring its smooth creation and eventual arrival on our screens? Not very often, right? Well, mutual funds in the world of finance are a bit like that overlooked movie producer, diligently doing their part in the background. They are the unsung heroes of many investment portfolios, often misunderstood and overshadowed by flashier investment options.

In this blog post, we’ll roll out the red carpet for mutual funds, bringing them to center stage. We’ll delve into their world, unmasking their advantages and disadvantages to help you, our distinguished audience, make informed decisions about your financial future. So, grab your popcorn, and let’s demystify mutual funds. Like a thrilling Bollywood potboiler, they have their highs, lows, elements of risk, rewards, and of course, a little bit of drama. So, ready for some financial ‘filmi’ action? Let’s begin.

The importance of mutual funds in personal finance is akin to that memorable Aamir Khan dialogue from 3 Idiots, “Life is a race … if you don’t run fast … you will be like a broken undaa (egg).” Well, with inflation running fast, if your money isn’t sprinting in the race of growth, it may end up being that ‘broken egg.’ This is where mutual funds can play a vital role, offering the potential for higher returns and a path to achieving your financial goals. But, like any Bollywood story, they come with their twists and turns, their benefits and pitfalls.

So, buckle up, as we embark on this journey to unravel the world of mutual funds. From “What are mutual funds?” to their pros and cons, we’ll cover everything. By the end, you’ll not only understand them better but may even become a fan, just like you might become of an underdog character in a feel-good Bollywood movie. Lights, camera, action, and…invest!

What are Mutual Funds?

Remember the heartwarming movie, ‘Chak De! India’? Shah Rukh Khan, the coach, brings together a diverse group of female hockey players to form a formidable team that ultimately wins the world cup. A mutual fund is a bit like that team. It’s a collective investment scheme, bringing together money from multiple investors, just like the team in the movie brings together players from different backgrounds.

A mutual fund pools money from various investors to invest in a portfolio of assets such as stocks, bonds, or other securities. Each investor in the fund owns units or shares, which represent a portion of the holdings of the fund. Managed by a professional fund manager (let’s call them the Shah Rukh Khan of our mutual fund movie), they make investment decisions based on rigorous research and their expert knowledge of the market.

Mutual funds in India have seen an upward trend, much like the popularity of OTT platforms. With a history dating back to 1963, when the government of India established Unit Trust of India (UTI), today there are numerous mutual funds catering to the diverse investment needs of millions of Indian investors.

Advantages of Mutual Funds

A. Professional Management

Remember how Rajnikanth’s character always has everything under control in his movies, even in the most chaotic situations? A mutual fund’s fund manager is somewhat like our very own Rajnikanth, expertly navigating the chaos of the financial market. The fund manager, backed by a team of researchers, uses their expertise to make investment decisions, aiming to generate maximum returns for the investors.

B. Diversification

Ever noticed how a Salman Khan movie usually has everything – drama, action, comedy, romance – offering something for everyone? Mutual funds offer a similar diversification. They spread investments across a range of assets to mitigate risk. If one asset underperforms, another might do well, balancing the overall performance – much like Salman Khan balancing multiple genres in a single movie.

C. Liquidity

You can quickly sell (redeem) your mutual fund units at the current fund’s net asset value (NAV) – much like you can easily stream your favourite Ranbir Kapoor movie online without having to wait for it to come on TV. The flexibility and convenience mutual funds offer make them a popular investment choice.

D. Affordability

Even with a small amount, one can start investing in mutual funds – it’s as affordable as a subscription to a streaming service. This accessibility makes mutual funds an attractive investment avenue for all, including beginners or those with limited resources.

E. Tax Benefits

Just like tax breaks in the film industry, mutual funds offer tax benefits too. Schemes like Equity Linked Savings Scheme (ELSS) provide tax deductions under section 80C of the Income Tax Act, making them a preferred choice for tax-saving.

Disadvantages/Limitations of Mutual Funds

A. Management Fees and Other Expenses

Just as you pay for your Netflix or Amazon Prime subscription, mutual funds come with fees too. The fund’s annual operating expenses, including management fees, administrative costs, and other asset-based costs, can impact your overall returns.

B. Market Risks

In the world of mutual funds, as in a suspense thriller, uncertainty can lurk around every corner. Mutual funds, particularly equity mutual funds, are subject to market risks. While the fund manager makes every effort to mitigate these risks, they cannot be eliminated entirely.

C. Limited Control

Investing in a mutual fund is like watching a director’s cut of a movie. You put your trust in the director’s (fund manager’s) vision, with little control over the individual investment choices.

D. Potential for Over-diversification

While diversification is good, over-diversification can dilute the returns – like too many sub-plots confusing the main narrative of a movie. It’s important to maintain a balance and not dilute the potential gains excessively.

V. Things to Consider before Investing in Mutual Funds

Investing in mutual funds should be as thoughtful a decision as selecting which movie to watch on a weekend. Understand your risk tolerance, align the investment with your financial goals, and consider the time horizon of your investment. Also, remember to monitor the fund’s performance periodically, just like keeping tabs on movie reviews!

Ways of Investing in Mutual Funds

Now that we have discussed the advantages and disadvantages of mutual funds, you may wish to know about the best ways to invest in them. 

So, there are two ways in which you can invest in MFs: SIP and Lump Sum 

But what’s a better option? Should you choose SIP or a lump sum investment mode? 

SIP Vs Lump Sum — What to Choose? 

A lump sum investment is the one where you’re required to invest a particular amount of money only one time. 

Whereas, an SIP (Systematic Investment Plan) allows you to invest in small amounts at regular intervals, say weekly, monthly or quarterly. 

Note that the returns in a lump sum mode depend on the situation of the market. The volatile nature of the market can sometimes adversely affect your returns. On the other hand, SIP yields better returns regardless of the market situation. 

If you want to earn good returns from a lump sum investment, then you can do so by planning and timing carefully. 

Choose Lump Sum investment only if you can stay invested for the long term and have a higher risk appetite. Further, if your risk-taking ability is low and you still want to invest a lump sum amount, then consider debt investments. Here the returns are lower but it is safer than other ways of investing. 

Coming back to SIP, it allows you to reduce the average cost of your investment and hence reduces the level of risk associated with the investment. Further, you can purchase MFs at different prices, which results in reducing the purchase cost and increasing the profits. 

To calculate the mutual fund returns of a SIP, you can easily use any SIP calculators that are available online. 

Calculate Returns on Mutual Funds

Calculating mutual fund returns helps investors have a clear idea about the amount he/she will earn as returns. The formula for calculating lump sum mutual fund returns manually is given below: 

M = P (1 + r/100)^n 

Where, M = amount you will receive at maturity,

  • P = principal amount you have invested,
  • r = estimated rate of return you earn on your investment, and
  • n = holding period in years

However, there is no need to spend a lot of time using such complicated formulas to compare mutual funds. Instead, you can use an online returns calculator to avoid errors and get accurate results within seconds.

Conclusion

And, cut! That’s a wrap on our cinematic journey through the world of mutual funds. Like a potboiler movie, they have their exciting aspects and their risky moments. Yet, for millions of investors across India, mutual funds are a preferred investment avenue. They offer a mix of benefits – professional management, diversification, liquidity, affordability, and tax benefits. But, as with any investment, they come with their limitations – fees, market risks, limited control, and potential over-diversification. So, take a director’s seat for your financial future, understand these aspects, and make informed investment decisions.

Frequently Asked Questions (FAQs)

What is a mutual fund?

Like a movie bringing together a cast of actors, a mutual fund pools money from various investors to invest in a diversified portfolio of assets.

What are the key advantages of investing in mutual funds?

Professional management, diversification, liquidity, affordability, and tax benefits are some key advantages of investing in mutual funds.

What are the potential limitations of investing in mutual funds?

Management fees, market risks, limited control, and potential over-diversification are some potential limitations of investing in mutual funds.

Is investing in mutual funds a good idea for beginners?

Yes, due to their affordability and professional management, mutual funds can be a good starting point for beginners.

How to start investing in mutual funds in India?

You can start by opening an account with a mutual fund company or through a financial advisor. Ensure to understand your financial goals, risk tolerance, and investment horizon before investing.