You have a plethora of choices when it comes to choosing an investment product. There is a large variety of options available, right from fixed deposits, stocks, gold or real estate, insurance, public provident fund and mutual funds.
Each product has its pros & cons and risks & rewards. However, if you are looking at an investment option that is professionally managed, diversified and offers a good risk-return trade off, Mutual Funds can be the right choice for you.
Mutual funds, unlike stocks, do not invest only in a particular share. Instead, a mutual fund plan would invest across several investment options to provide investors with the best possible returns.
Also, investors are not required to do their research to pick best-performing stocks as the fund manager, and his team of analysts and market researchers do the research and choose the top-performing instruments that have the potential to offer high returns.
By investing in mutual funds, the investors need not worry about the concentration risk as the fund manager mitigates this by investing across several instruments.
Therefore, investing in mutual funds is an excellent way of diversifying your investment portfolio.
Before diving into the benefits of investing in Mutual Funds, lets understand different types of Mutual Funds:
There are four broad types of mutual funds: Equity (stocks), fixed-income (bonds), money market funds (short-term debt), or both stocks and bonds (balanced or hybrid funds).
- Equity funds
Equity mutual funds buy stocks of a collection of publicly traded companies. They have a higher potential for growth but more potential volatility in value. Equity mutual funds can be sliced and diced in several ways depending on the goals of the fund:
1.1. Funds based on company size
Some funds focus only on “large cap” or “small cap” companies, which refers to the market capitalization, or value, of the companies:
- Large-cap fund: Companies with a market value of $10 billion or greater.
- Mid-cap fund: Companies worth $2 billion to $10 billion.
- Small-cap fund: Companies worth $300 million to $2 billion.
1.2. Industry or sector funds
These mutual funds focus on a particular industry, such as technology, oil and gas, aviation or health care. For example, investors who want exposure to gains by companies like Infosys, TCS, Google and Apple could put money in a technology fund. Ownership in different sector funds can help diversify your portfolio, so if one industry is hit hard (like the bursting of the dot-com stock bubble in 2000), those losses can be offset by gains in other sectors.
1.3. Growth and value funds
The investment style of the fund is another mutual fund differentiator. Growth funds, as the name suggests, seek stocks that fund managers believe will have better than average returns. Growth funds are an equity mutual fund portfolio aiming at capital appreciation and usually do not have any dividend payment – and rather focus on consistent reinvestment.
On the other hand, value funds look for companies whose stock is undervalued by the market. These stocks may not be doing well in the market currently but the fund managers may think that they have a great potential for growth. For example, some popular value funds in India include: L&T India Value Fund, Templeton India Equity Income Fund and ICICI Prudential Value Discovery Fund.
1.4. International, global and emerging market funds
Geographic location can also determine how mutual funds are built. International funds invest in companies doing business outside the U.S., while global funds invest in companies doing business both in the U.S. and abroad. Emerging market funds target countries with relatively smaller but consistently growing markets.
- Bond funds
Bond funds are the most common type of fixed-income mutual funds, where (as the name suggests) investors are paid a fixed amount back on their initial investment. Bond funds are the second most popular mutual fund type. Just as advisors say equity funds favor the young, investors nearing retirement can have more bond funds in their portfolio.
2.1. Money market funds
Money market mutual funds are fixed-income mutual funds that invest in high-quality, short-term debt from governments, banks or corporations. Examples of assets held by these funds include U.S. Treasuries, certificates of deposit and commercial paper. They are considered one of the safest investments and make up 15% of the mutual fund market, according to the ICI.
2.2. Balanced funds
Also known as asset allocation funds, these investments are a combination of equity and fixed-income funds with a fixed ratio of investments such as 60% stocks and 40% bonds. The best-known variety of these funds are target-date funds, which automatically reallocate the ratio of investments from equities to bonds the closer you get to retirement.
- Index Funds
Index Fund is a type of mutual fund whose holdings match or track a particular market index, such as the S&P 500. Index funds have exploded in popularity in recent years, thanks to the rise of passive investing strategy, which, over time, typically earns better returns than an actively managed approach. Like equity funds, index funds can vary by company size, sector and location.
- Specialty or Alternative Funds
The catch-all category of funds includes hedge funds, managed futures, commodities and real estate investment trusts. There is also growing investor interest in corporate socially responsible mutual funds, which avoid investing in industries like tobacco or firearms and instead focus on funding companies with strong environmental and labor practices.
Benefits of Investing in Mutual Funds:
Investing in mutual funds provides several advantages for investors. To name a few, flexibility, diversification, and expert management of money, which make mutual funds an ideal investment option.
- Investment Handled by Professionals and Experts ( Fund Managers )
Professional Fund managers manage the investments pooled by the asset management companies (AMCs) or fund houses. These are finance professionals who have a solid understanding of the financial markets, and usually carry an excellent track record of managing investment portfolios. Furthermore, fund managers are backed by a team of analysts and experts who pick the best-performing stocks and assets that have the potential to provide excellent returns for investors in the long run.
- No Lock-in Period
Most mutual funds come with no lock-in period. In investments, the lock-in period is a period over which the investments once made cannot be withdrawn. Some investments allow premature withdrawals within the lock-in period in exchange for a penalty. Most mutual funds are open-ended – but many of them do come with varying exit loads on redemption, if done before a certain time period. Only ELSS mutual funds come with a lock-in period.
3. Low Cost, High Expertise
Investing in mutual funds usually comes at a low cost, thereby making it suitable for small investors. Mutual fund houses or asset management companies (AMCs) levy a small amount referred to as the expense ratio on investors to manage their investments. It generally ranges between 0.5% to 1.5% of the total amount invested. The Securities and Exchange Board of India (SEB) has mandated the expense ratio to be under 2.5% – so you got professional fund management at affordable prices!
4. SIP ( Systematic Investment Plan )
The most significant advantage of investing in mutual funds is that you can invest a small amount regularly via a SIP (systematic investment plan). The frequency of your SIP can be monthly, quarterly, or bi-annually, as per your comfort and aggressiveness. Also, you can decide the ticket size of your SIP. However, it cannot be less than the minimum investable amount. You can initiate or terminate a SIP as and when you need. Investing via SIPs alleviates the need to arrange for a lump sum to get started with your mutual fund investment. You can stagger your investments over time with an SIP, and this also gives you the benefit of cost averaging in the long run.
5. Diversification of Portfolio
Mutual funds invest across asset classes and shares of several companies, thereby providing you with the benefit of diversification. Also, this reduces the concentration risk to a great extent. If one asset class fails to perform up to the expectations, then the other asset classes would make up for the losses. Therefore, investors need not worry about market volatility as the diversified portfolio would provide some stability.
6. Flexibility of Investments
Mutual funds are buzzing these days because they provide the much-needed flexibility to the investors, which most investment options lack in. The combination of investing via an SIP and no lock-in period has made mutual funds an even more lucrative investment option. This means that people may consider investing in mutual funds to accumulate an emergency fund. Also, you can enter and exit a mutual fund plan at any time, which may not be the case with most other investment options. It is for this reason that millennials are preferring mutual funds over any other investment vehicle.
7. High Liquidity
Since most mutual funds come with no lock-in period, it provides investors with a high degree of liquidity. This makes it easier for the investor to fall back on their mutual fund investment at times of financial crisis. The redemption request can be placed in just a few clicks, and the requests are processed quickly. On placing the redemption request, the fund house or the asset management company would usually credit your money to your bank account in just 3-7 business days usually.
8. Strongly Regulated
All mutual fund houses and mutual fund plans are always under the purview of the Securities and Exchange Board of India (SEBI) and Reserve Bank of India(RBI). Apart from that, the Association of Mutual Funds in India (AMFI) is a non-profit government organisation in the Mutual Funds’ sector that acts as a primary regulator under SEBI. Therefore, investors need not worry about the safety of their mutual fund investments.
9. Ease of Performance Tracking
One of the most significant advantages of investing in mutual funds is that tracking investments is easy and straightforward. Fund houses understand that it is hard for investors to take some time out of their busy schedules to track their finances, and hence, they provide regular statements of their investments. This makes it a lot easier for them to track their investments and make decisions accordingly. You can also track your investments on your providers / brokers online apps and portals (including Share India)
10. Tax-Saving Benefits
ELSS or Equity-Linked Savings Scheme is an equity-oriented mutual fund which provides tax deductions of up to Rs 1,50,000 a year under the Section 80C provision. By making full utilisation of the Section 80C limit, you can save up to Rs 46,800 a year in taxes.
ELSS is the most popular tax-saving investment option under Section 80C of the Income Tax Act, 1961. It comes with a lock-in period of just three years, the shortest of all tax-saving investments. Investing in ELSS provides you with the dual benefit of tax deductions and wealth accumulation over time.
Once an investor identifies and understands the above factors, they can align them to a mutual fund scheme that suits them. Investors may also choose to seek the counsel of a financial advisor to make prudent investment decisions with ShareIndia.
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Disclaimer: Any Advice or information in the post is general advice for education purpose only and is not responsible for generating any trading profits for anyone, please do not trade or invest based solely on this information.