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Investing in mutual funds presents numerous benefits that appeal to both seasoned investors and newcomers alike. These investment vehicles offer a diversified and professionally managed approach to wealth accumulation, making them a popular choice among investors worldwide. Here are ten compelling reasons why one should consider investing in mutual funds.
Table of Contents
Defining Mutual Funds
Mutual funds are investment vehicles that pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities. These funds are managed by professional fund managers who make investment decisions on behalf of the investors, aiming to achieve specific investment objectives. Investors purchase shares in the mutual fund, which represents their proportional ownership of the fund’s holdings. Mutual funds offer a convenient and accessible way for investors to gain exposure to various asset classes and investment strategies, catering to a wide range of investment goals and risk tolerances.
Types of Mutual Funds
1. 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:
Funds based on company size
Some funds focus only on large cap or small cap companies, which refers to the market capitalisation, 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.
Know about the difference between small, mid, large cap funds here.
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 one’s 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.
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.
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 US, while global funds invest in companies doing business both in the US and abroad. Emerging market funds target countries with relatively smaller but consistently growing markets.
2. 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 favour the young, investors nearing retirement can have more bond funds in their portfolio.
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.
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 is target-date funds, which automatically reallocate the ratio of investments from equities to bonds the closer one gets to retirement.
Index funds
An 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 labour 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, make mutual funds an ideal investment option.
Investment Handled by Professionals and Experts (Fund Managers)
Professional fund managers manage the investments pooled by 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. Get a clear picture of one’s investment performance with our CAGR online calculator.
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.
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%
SIP (Systematic Investment Plan)
The most significant advantage of investing in mutual funds is the ability to invest a small amount regularly through a SIP (Systematic Investment Plan). The frequency of SIPs can be monthly, quarterly, or bi-annually, according to one’s comfort and investment strategy. Additionally, one can determine the ticket size of the SIP, provided it meets the minimum investable amount. SIPs offer the flexibility to initiate or terminate investments as needed, eliminating the requirement for a lump sum to start investing in mutual funds. By staggering investments over time with a SIP, investors benefit from cost averaging in the long run.
Diversification of Portfolio
Mutual funds invest across asset classes and shares of several companies, thereby providing one 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.
Flexibility of Investments
Mutual funds are gaining popularity due to the flexibility they offer investors, a feature lacking in many other investment options. The ability to invest through a SIP without a lock-in period has made mutual funds particularly appealing. This flexibility makes them an attractive option for building an emergency fund. Additionally, investors can enter and exit mutual fund plans at any time, unlike many other investment vehicles. As a result, millennials are increasingly favouring mutual funds over alternative investment options.
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 one’s money to the bank account in just 3-7 business days usually.
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.
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. One can also track the investments on one’s providers/brokers online apps and portals (including Share India)
Tax-Saving Benefits
- ELSS (Equity Linked Savings Scheme): ELSS mutual funds offer tax benefits under Section 80C of the Income Tax Act, allowing investors to claim deductions on investments up to ₹1.5 lakh annually. Investments in ELSS have a lock-in period of three years.
- Dividend Distribution Tax (DDT): Mutual funds investing in equities do not levy dividend distribution tax on dividends received by investors. However, dividends are subject to tax at the individual’s applicable tax rate.
- Capital Gains Tax: Long term capital gains (if holding period exceeds one year) from equity mutual funds are tax-exempt up to ₹1 lakh per financial year. Beyond this limit, gains are taxed at 10%. Short term capital gains (holding period of one year or less) are taxed at a flat rate of 15%.
- Tax Benefits on Debt Funds: Debt mutual funds offer indexation benefits on long term capital gains, reducing the tax burden by adjusting gains for inflation. Short term capital gains from debt funds are taxed at the individual’s applicable tax rate.
Conclusion
Mutual funds present a range of benefits that make them a compelling investment option for individuals at all stages of their financial journey. From professional management and diversification to accessibility and tax-saving advantages, mutual funds offer a versatile approach to wealth accumulation and financial security. Whether one is seeking to enhance the portfolio or build a brighter financial future, mutual funds provide an effective means to achieve one’s investment goals.