Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic diversification they offer, as well as the advantages of professional management, liquidity, and customizability.

Mutual fund investors own shares in a company whose business is buying shares in other companies (or in bonds, or other securities). Mutual fund investors don’t directly own the stock in the companies the fund purchases, but they do share equally in the profits or losses of the fund’s total holdings — hence the “mutual” in mutual funds.

• What is a Mutual Fund?
• Why Mutual Funds are Popular in India?
• 7 Common Types of Mutual Funds?
• Why is Mutual Fund Important?
• What is the Biggest Advantage of a Mutual Fund?
• When did Mutual Funds Become Popular?
• Why Mutual Funds are Better Than Shares?
• What is Unique About Mutual Funds?
• Why Mutual Funds are Attractive to Small Investors?
• What is the Most Popular Fund?
• Why Mutual Funds are Better Than Other Investment Options?
• What Makes Mutual Fund Grow?
• Is Mutual Fund Really Profitable?

What is a Mutual Fund?

A mutual fund is a professionally managed investment fund that pools money from a large number of investors to buy a variety of securities, such as stocks, bonds, money market instruments (e.g., treasury bills), or other securities. When you buy a share in a mutual fund, you own a portion of all the investments in that fund.

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Mutual funds are open-end investment funds, which means they can issue unlimited new shares. In other words, shares are issued as long as there are investors interested in the fund. If you choose to sell your fund shares, you sell them back at their current value, minus any fees.

If you’re a beginner investor or prefer to take a hands-off approach, it’s worth considering how mutual fund shares can help you reach your investment goals.

Why Mutual Funds are Popular in India?

Mutual funds in India work in much the same way as mutual funds in the United States. Like their American counterparts, Indian mutual funds pool the investments of many shareholders and invest them in a variety of securities depending on the goals of the fund.

Also like U.S. funds, there is a wide range of different fund types available for purchase depending on the needs and risk tolerance of any given investor. Mutual funds are a popular investment option in India because, like American funds, they offer automatic diversification, liquidity, and professional management.

Any type of mutual fund that exists in the U.S. is mirrored in some way in the Indian market. There are mutual funds that invest in equity or stocks and are managed to achieve a range of goals. Some equity mutual funds are designed to generate long-term capital gains through growth or value investing strategies, like the Birla SL Frontline Equity Fund, while others are focused on generating dividend income for shareholders. Some combine the two, such as the popular ICICI Prudential Equity & Debt Fund.

Indian mutual funds may also invest in bonds and other debt securities with the goal of generating regular interest income. Indian debt funds invest in government or corporate debt instruments and money market securities just like American funds.

There are also Indian balanced funds that invest in both equity and debt instruments to create portfolios that offer a degree of stability without completely ignoring the potential for big gains in the stock market. A good example is the DSP Equity Opportunities Fund.

Just like in the American market, the Indian market offers mutual funds that specialize in certain sectors, only invest in government or inflation-protected debt, track a given index, or are designed to maximize tax efficiency.

Regulation

Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI). Indian mutual funds are subject to stringent requirements about who is eligible to start a fund, how the fund is managed and administrated and how much capital a fund must have on hand.

To start a mutual fund, for example, the fund sponsor must have been in the financial industry for at least five years and have maintained a positive net worth for the five years immediately preceding the registry.

The SEBI regulations include a minimum startup capital requirement of Rs. 500 million for open-ended debt funds and Rs. 200 million for closed-ended funds. In addition, Indian mutual funds are only allowed to borrow up to 20% of their value for a term not to exceed six months to meet short-term liquidity requirements.

Mutual Fund Management Structure

The mutual fund sponsor, either an individual, group of individuals or corporate body, is responsible for applying for registry with SEBI. Once approved, the sponsor must form a trust to hold the assets of the fund, appoint a board of trustees or trust company, and choose an asset management company.

The board of trustees or trust company is responsible for overseeing the mutual fund and ensuring it operates with the best interests of its shareholders in mind. The asset management company is the entity in charge of managing the fund’s portfolio and communicating with shareholders.

If the asset manager wishes to expand the product line, introduce a new scheme or change an existing one, it must first obtain approval from the board of trustees or trust company. In addition, the trustees must appoint a custodian and depository participant who is responsible for keeping track of asset trading activity and safeguarding both the tangible and intangible assets of the fund.

7 Common Types of Mutual Funds?

1. Money market funds

These funds invest in short-term fixed-income securities such as government bonds, treasury bills, bankers’ acceptances, commercial paper and certificates of deposit. They are generally a safer investment, but with a lower potential return then other types of mutual funds. Canadian money market funds try to keep their net asset value (NAV) stable at $10 per security.

2. Fixed income funds

These funds buy investments that pay a fixed rate of return like government bonds, investment-grade corporate bonds and high-yield corporate bonds. They aim to have money coming into the fund on a regular basis, mostly through interest that the fund earns. High-yield corporate bond funds are generally riskier than funds that hold government and investment-grade bonds.

3. Equity funds

These funds invest in stocks. These funds aim to grow faster than money market or fixed income funds, so there is usually a higher risk that you could lose money. You can choose from different types of equity funds including those that specialize in growth stocks (which don’t usually pay dividends), income funds (which hold stocks that pay large dividends), value stocks, large-cap stocks, mid-cap stocks, small-cap stocks, or combinations of these.

4. Balanced funds

These funds invest in a mix of equities and fixed income securities. They try to balance the aim of achieving higher returns against the risk of losing money. Most of these funds follow a formula to split money among the different types of investments. They tend to have more risk than fixed income funds, but less risk than pure equity funds. Aggressive funds hold more equities and fewer bonds, while conservative funds hold fewer equities relative to bonds.

5. Index funds

These funds aim to track the performance of a specific index such as the S&P/TSX Composite Index. The value of the mutual fund will go up or down as the index goes up or down. Index funds typically have lower costs than actively managed mutual funds because the portfolio manager doesn’t have to do as much research or make as many investment decisions.

6. Specialty funds

These funds focus on specialized mandates such as real estate, commodities or socially responsible investing. For example, a socially responsible fund may invest in companies that support environmental stewardship, human rights and diversity, and may avoid companies involved in alcohol, tobacco, gambling, weapons and the military.

7. Fund-of-funds

These funds invest in other funds. Similar to balanced funds, they try to make asset allocation and diversification easier for the investor. The MER for fund-of-funds tend to be higher than stand-alone mutual funds.

Why is Mutual Fund Important?

1. Professional Management — Investors may not have the time or the required knowledge and resources to conduct their research and purchase individual stocks or bonds. A mutual fund is managed by full-time, professional money managers who have the expertise, experience and resources to actively buy, sell, and monitor investments.

A fund manager continuously monitors investments and rebalances the portfolio accordingly to meet the scheme’s objectives. Portfolio management by professional fund managers is one of the most important advantages of a mutual fund.

2. Risk Diversification — Buying shares in a mutual fund is an easy way to diversify your investments across many securities and asset categories such as equity, debt and gold, which helps in spreading the risk – so you won’t have all your eggs in one basket. This proves to be beneficial when an underlying security of a given mutual fund scheme experiences market headwinds. With diversification, the risk associated with one asset class is countered by the others.

Even if one investment in the portfolio decreases in value, other investments may not be impacted and may even increase in value. In other words, you don’t lose out on the entire value of your investment if a particular component of your portfolio goes through a turbulent period. Thus, risk diversification is one of the most prominent advantages of investing in mutual funds.

3. Affordability & Convenience (Invest Small Amounts) — For many investors, it could be more costly to directly purchase all of the individual securities held by a single mutual fund. By contrast, the minimum initial investments for most mutual funds are more affordable.

4. Liquidity — You can easily redeem (liquidate) units of open-ended mutual fund schemes to meet your financial needs on any business day (when the stock markets and/or banks are open), so you have easy access to your money. Upon redemption, the redemption amount is credited in your bank account within one day to 3-4 days, depending upon the type of scheme e.g., in respect of Liquid Funds and Overnight Funds, the redemption amount is paid out the next business day.

However, please note that units of close-ended mutual fund schemes can be redeemed only on maturity. Likewise, units of ELSS have a 3-year lock-in period and can be liquidated only thereafter.

5. Low Cost — An important advantage of mutual funds is their low cost. Due to huge economies of scale, mutual fund schemes have a low expense ratio. The expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the fund’s daily net assets. Operating expenses of a scheme are administration, management, advertising-related expenses, etc. The limits of expense ratio for various types of schemes has been specified under Regulation 52 of SEBI Mutual Fund Regulations, 1996.

6. Well-Regulated — Mutual Funds are regulated by the capital markets regulator, Securities and Exchange Board of India (SEBI) under SEBI (Mutual Funds) Regulations, 1996. SEBI has laid down stringent rules and regulations keeping investor protection, transparency with appropriate risk mitigation framework and fair valuation principles.

7. Tax Benefits —Investment in ELSS upto ₹1,50,000 qualifies for tax benefit under section 80C of the Income Tax Act, 1961. Mutual Fund investments when held for a longer term are tax efficient.

What is the Biggest Advantage of a Mutual Fund?

There are a variety of funds covering different industries and different asset classes available. Some of the advantages of this kind of investment include advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing.

Here’s a more detailed look at both the advantages of this investment strategy.

There are many reasons why investors choose to invest in mutual funds with such frequency. Let’s break down the details of a few.

Advanced Portfolio Management

When you buy a mutual fund, you pay a management fee as part of your expense ratio, which is used to hire a professional portfolio manager who buys and sells stocks, bonds, etc.1 This is a relatively small price to pay for getting professional help in the management of an investment portfolio.

Dividend Reinvestment

As dividends and other interest income sources are declared for the fund, they can be used to purchase additional shares in the mutual fund, therefore helping your investment grow.

Risk Reduction (Safety)

Reduced portfolio risk is achieved through the use of diversification, as most mutual funds will invest in anywhere from 50 to 200 different securities—depending on the focus. Numerous stock index mutual funds own 1,000 or more individual stock positions.

Convenience and Fair Pricing

Mutual funds are easy to buy and easy to understand. They typically have low minimum investments and they are traded only once per day at the closing net asset value (NAV). This eliminates price fluctuation throughout the day and various arbitrage opportunities that day traders practice.

When did Mutual Funds Become Popular?

Mutual funds didn’t really capture the attention of American investors until the 1980s and 1990s, when investors in them hit record highs and realized incredible returns. They are now mainstream investments and form the core of individual retirement accounts. However, the idea of pooling assets for investment purposes has been around for centuries.

Here we look at the evolution of this investment vehicle, from its beginnings in the Netherlands in the 19th century to its status as a global industry, with fund holdings accounting for trillions of dollars in the U.S. alone.

Historians are uncertain of the origins of investment funds, although many look to the Dutch as the early innovators who created the first closed-end investment companies.

Subhamoy Das, in his economics textbook “Perspectives on Financial Services,” traces an early appearance of the mutual fund to Dutch merchant Adriaan van Ketwich, who created an investment trust in 1774. “Van Ketwich probably believed that diversification would appeal to investors with minimal capital. The name of van Ketwich’s fund, Eendragt Maakt Magt, translates into ‘unity creates strength,’” the book explains.

Other examples followed, including an investment trust launched in Switzerland in 1849 and similar vehicles formed in Scotland in the 1880s.

U.S. Innovations

The idea of pooling resources and spreading risk using closed-end investments found its way to the U.S. by the 1890s. The Boston Personal Property Trust, formed in 1893, was the first closed-end fund in the U.S. According to Collins Advisors, the investments were primarily in real estate and the vehicle might today be described as a hedge fund rather than a mutual fund.

The creation of the Alexander Fund in Philadelphia in 1907 was an important step toward what we know as the modern mutual fund. The Alexander Fund featured semiannual issues and allowed investors to make withdrawals on demand.

The Arrival of the Modern Fund

The creation of the MFS Massachusetts Investors’ Trust in Boston marked the arrival of the modern mutual fund in 1924, according to Bianco Research.3 The fund was opened to investors in 1928, eventually spawning the mutual fund firm known today as MFS Investment Management. State Street Investors’ Trust was the custodian of the Massachusetts Investors’ Trust.

The year 1929 saw the launch of the Wellington Fund, which was the first balanced fund, including both stocks and bonds. The Vanguard Wellington Fund (VWELX) is still in existence today and claims to be America’s oldest balanced fund.

Despite the 2003 mutual fund scandals and the global financial crisis of 2008-09, the story of the mutual fund is far from over. In fact, the industry is still growing. In the U.S. alone there are more than 10,000 mutual funds, and if one accounts for all share classes of similar funds, fund holdings are measured in the trillions of dollars.

Despite the launch of separate accounts, exchange-traded funds, and other competing products, the mutual fund industry remains healthy and fund ownership continues to grow.

Why Mutual Funds are Better Than Shares?

Mutual Funds and Shares have become the most popular investment avenues available to people. According to recent data, 31% of Indians are investing in Mutual Funds, whereas 10% are investing in shares in 2022. It is essential to have proper knowledge of all the investment avenues available and then make an informed choice. There are a lot of debates every day over the stock market vs mutual funds and which one is a better investment avenue.

In simple words, Shares represent the unit of holdings in equities of a company. The people who own the shares are known as shareholders and own a small part of the company whose shares they hold. One can buy shares directly through trading apps or brokers. 

People these days are willing to explore various investment avenues to try and maximize their returns. Shares are a great option available. A lot of people wish to have a business of their own but due to some reasons they do not end up with one, shares give them a chance to invest in the businesses of different people and represent their interests/views. 

In India, the share market is regulated by the Securities and Exchange Board of India (SEBI) under the SEBI Act 1992.

One can invest in shares through Initial Public Offering (IPO) or the secondary market. It is a basic exchange in which the main owner of the company gets capital to grow the business and the investors get a small part of ownership in the company. The investors benefit when the company grows. They simply invest because they trust in that company and see potential growth.

When the company grows, more people are willing to buy the shares and hence the demand rises and so do the share prices. And this is how the investors benefit as the price of their shareholdings increases and they earn profit. As companies grow, they also earn profits and majorly invest them back in the business, whereas some can be distributed to the shareholders in the form of dividends.

Earlier, these shares were issued in materialized forms of certificates but now everything has turned dematerialized and so has the ownership of these shares. One needs to open a Demat and a trading account in an investment platform to invest in shares.

Which is Better?

To solve the debate about Stocks vs Mutual Funds, one needs to know the difference between the two and decide whether to invest in Mutual Fund or Stock Market.

The following are a few of the differences one should be aware of:

• The investment in shares is managed by the investor himself, whereas the investment in mutual funds is managed by a professional fund manager.
• While investing in shares, the investor needs to research on his own, whereas in mutual funds, the fund houses manage this part too. Thereby mutual funds can save time for the investors.
• In shares, an investor has to invest in individual shares and has the option to invest in multiple shares of his own choice. Whereas, in mutual funds, the whole amount is invested in a diversified set of assets based on the investment purpose and goals of the investors.
• Shares are subject to market risk. So are mutual funds but the risk is reduced as the amount is invested in various assets.
• While investing in shares, you can only invest in shares and own a part of the respective company. Whereas in mutual funds, you can invest in various assets like bonds too. Hence, diversification is offered in investing in Mutual Funds.
• Since fund houses are such big participants in the market, they have more reach and knowledge than a common person who is investing in shares by himself.
• Investment in shares requires a lot of money at times as the shares can be priced higher due to market forces. Whereas, mutual funds give you a chance to buy a part of the same company as the fund house combines the money of various investors to invest in diverse investment avenues.
• Investing in shares gives you a chance to follow your form of investment and even go against the flow.
• You can invest in a SIP in Mutual Funds, whereas you can not do that in shares as the price of shares keeps fluctuating, and hence your amount of investment will vary.
• You choose the stocks to invest in while investing directly, but you do not have that option while investing in Mutual Funds.

Every investor is different and so is their form of investment. It depends on the investor what features he wants to avail and choose the right investment avenue based on his investment purpose, the timeline of investment, and the amount of risk he is willing to take.

What is Unique About Mutual Funds?

Mutual funds are operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors. A mutual fund’s portfolio is structured and maintained to match the investment objectives stated in its prospectus.

Mutual funds give small or individual investors access to professionally managed portfolios of equities, bonds, and other securities. Each shareholder, therefore, participates proportionally in the gains or losses of the fund. Mutual funds invest in a vast number of securities, and performance is usually tracked as the change in the total market cap of the fund—derived by the aggregating performance of the underlying investments.

Most mutual funds are part of larger investment companies such as Fidelity Investments, Vanguard, T. Rowe Price, and Oppenheimer. A mutual fund has a fund manager, sometimes called its investment adviser, who is legally obligated to work in the best interest of mutual fund shareholders.

Why Mutual Funds are Attractive to Small Investors?

For investors with limited time to spend watching the ups and downs of the markets, mutual funds offer a good alternative. Here are a few reasons to give up individual stock picking and turn to mutual funds.

Diversification

One golden rule of investing for both large and small investors is to go for asset diversification. That involves reducing the risk to your assets by buying a mix of stocks from different industries and investments of different types. For example, buying both retail and industrial stocks reduces the impact on your portfolio of a poor quarter in one of those sectors. And putting some of your money in bonds protects you from a precipitous drop in stocks.

To achieve a truly diversified portfolio, you would have to buy several stocks of companies in various industries plus bonds with different dates of maturity from several issuers. Such a wide selection is beyond the reach of most individual investors. By purchasing mutual funds, you get instant diversification.

One caveat, however, is that you might not get adequate diversification by investing in a single mutual fund. Don’t put all your money in a single sector-specific or industry-specific fund. An oil and energy mutual fund might spread your money over 50 companies, but if energy prices fall, your savings will suffer.

Instead, look for a fund that will spread your assets among several leading industries. You’ll take advantage of pop in any one of them while avoiding a big hit if one sector has a rough year.

Economies of Scale

The easiest way to understand economies of scale is to consider the volume discount. In many stores, the more of a product you buy, the less it costs. A dozen donuts can be cheaper per donut than buying three. This also occurs in the purchase and sale of securities. If you buy one share of stock, the transaction fee will be the same as if you bought 1,000 shares. That’s a hefty bite out of your investment in one share, but a negligible nibble out of 1,000 shares.

Mutual funds take advantage of their buying and selling volume to reduce transaction costs for their investors. When you buy a mutual fund, you diversify without paying the 10 to 20 transaction fees that would give you a similarly diverse individual portfolio. And that’s just the initial purchase fees. Take into account the transaction fees for every modification to your portfolio and the costs add up.

Divisibility

The owner of a mutual fund can invest a regular round sum every month, say $100 or $200. That gives the investor another tiny bite of many assets. A stock-picker, by contrast, might get one or two shares of stock, with an odd number of dollars left over. Or the investor can save up for many months to get one share of Amazon.

These periodic investments in a mutual fund also allow the investor to take advantage of the benefits of dollar-cost averaging, a strategy that cushions a portfolio from the impact of price volatility.

So, rather than waiting until you have enough money to buy higher-cost investments, you can get in right away with a mutual fund. This choice provides an additional advantage: liquidity.

Liquidity

An investor who is hit with a financial emergency might have to sell out in a hurry. That can be disastrous if the assets have taken a hit at the wrong moment. It tends to be less so in mutual funds, which swing in value less wildly because of their diversification.

Watch out for any fees associated with selling, including back-end load fees, which are percentages deducted from your total when you sell the fund. Also, note that mutual funds, unlike stocks and exchange-traded funds, transact only once per day after the fund’s net asset value is calculated.

Professional Management

When you buy a mutual fund, you also are choosing a professional money manager. This manager makes the decisions on how to invest your money, based on a good deal of research and an overall strategy for making money. Only you can decide whether you are more comfortable with that than with making the decisions on your own.

What is the Most Popular Fund?

The list below includes index funds from a variety of companies tracking a variety of broadly diversified indexes and it includes some of the lowest-cost funds you can buy and sell on the public markets. When it comes to index funds like these, one of the most important factors in your total return is cost.

Rank	Symbol	Fund Name
1	VSMPX	Vanguard Total Stock Market Index Fund; Institutional Plus
2	VFIAX	Vanguard 500 Index Fund; Admiral
3	FXAIX	Fidelity 500 Index Fund
4	VTSAX	Vanguard Total Stock Market Index Fund; Admiral
5	SPAXX	Fidelity Government Money Market Fund
6	VMFXX	Vanguard Federal Money Market Fund; Investor
7	FDRXX	Fidelity Government Cash Reserves
8	FGTXX	Goldman Sachs FS Government Fund; Institutional
9	VGTSX	Vanguard Total International Stock Index Fund; Investor
10	VIIIX	Vanguard Institutional Index Fund; Inst Plus
11	OGVXX	JPMorgan US Government Money Market Fund; Capital
12	TFDXX	BlackRock Liquidity FedFund; Institutional
13	VTBIX	Vanguard Total Bond Market II Index Fund; Investor
14	VFFSX	Vanguard 500 Index Fund; Institutional Select
15	VTBNX	Vanguard Total Bond Market II Index Fund; Institutional
16	TTTXX	BlackRock Liquidity Treasury Trust Fund; Institutional
17	MVRXX	Morgan Stanley Inst Liq Government Port; Institutional
18	AGTHX	American Funds Growth Fund of America; A
19	VINIX	Vanguard Institutional Index Fund; Institutional
20	FTIXX	Goldman Sachs FS Treasury Instruments Fund; Instituitonal
21	DGCXX	Dreyfus Government Cash Management; Institutional
22	VBTLX	Vanguard Total Bond Market Index Fund; Admiral
23	VMRXX	Vanguard Cash Reserves Federal Money Market Fd; Adm
24	ABALX	American Funds American Balanced Fund; A
25	VWENX	Vanguard Wellington Fund; Admiral

Why Mutual Funds are Better Than Other Investment Options?

Over the last few years, mutual funds have become the preferred investment option for a lot of people. In a country like ours, where people have traditionally been risk-averse and have only trusted FDs and gold, it is a significant shift.

But, have you ever wondered what is causing this shift and why is everyone looking to invest in mutual funds? Why are FDs, gold and other traditional saving options losing their appeal?

From diversification, professional management, and liquidity to customizability, there are a lot of features that set mutual funds apart. But, how does these feature work for your benefit?

Professional Management

One of the biggest advantages of mutual funds is that your money is being managed by experts. Each fund is helmed by a fund manager who has in-depth knowledge of financial markets and has years of experience in managing money.

The fund manager and his team continuously monitor various securities and economic variables and keeps optimizing your portfolio as per changing market conditions. This ensures you get the best possible returns on your investments, without having to keep track of the best investment opportunities continuously.

Liquidity

Liquidity is an essential aspect of any investment. And one of the chief benefits of investing in mutual funds is that your investment always remains accessible to you.

Most funds do not have any lock-in period (apart from ELSS funds), which means you can redeem your investments whenever you need the money. The mutual fund houses are obligated to accept your redemption request and credit the money in your account within a defined time-frame (typically in 1–2 working days).

This flexibility of selling and buying is somewhat unique to mutual funds. Investments like real estate can be highly illiquid, and while you can break your fixed deposits, it means penalty plus a lesser interest rate.

Customizability

There is a mutual fund scheme available for every possible investment objective.

Whatever might be your investment goal, time-frame for investment or your risk appetite, you are sure to find a scheme that will suit your need.

From high-risk, high-reward equity funds to low-risk debt funds that offer slower, steadier growth, as well as everything in between, mutual funds are perfect for your different investment objectives.

Low Costs

Mutual funds are some of the most cost-effective investment avenues available. There are two types of cost in mutual funds- the fees mutual fund house charges and the cost of buying and selling your investments.

For zero-commission direct plans, the mutual fund house typically takes somewhere between 0.5%-1.5% of the returns generated. This is a minuscule amount for the professional expertise, liquidity and high returns they provide.

The transaction cost that needs to be incurred for buying and selling your mutual fund investments is now zero, thanks to ETMONEY where you get free for life account, which offers unlimited free transactions, further bringing down the costs.

Better Returns

Equity mutual funds over the long term have beaten most investment options when it comes to returns generated.

That’s because equity funds invest your money in companies that are driving India forward, and you directly benefit from the growth of these companies.

So for your long-term investment objectives, equity mutual funds come across as the only investment option capable of beating standard inflation rates over the years and in turn help you build a sizeable corpus required to fulfill your goals.

Well regulated

All mutual fund houses function under the purview of SEBI (Securities and Exchange Board of India).

SEBI is a government agency that supervises the mutual fund industry and works to safeguard the interests of the investors. A close check by such a regulatory agency ensures transparency in the operations of these funds.

Diversification

Mutual funds allow you to have a diversified portfolio in a much easier and cost-effective way.

When you invest in a mutual fund scheme, the scheme based on its mandate puts your money not in companies across industries and sectors, but also across asset classes such as equity, debt, etc. This spreading out reduces risk as all asset classes/securities rarely fall at the same time.

What Makes Mutual Fund Grow?

When it comes to mutual funds, you can make money in three possible ways:

1. Income earned from dividends on stocks and interest on bonds. A mutual fund pays out nearly all of the net income it receives over the year (in the form of a distribution).
2. An increase in the price of securities (called a ‘capital gain’). Most funds also pass these gains on to their investors.
3. The fund share price increases. This happens if fund holdings increase in price. You can then sell your shares for a profit.

You are usually given the choice of whether to receive a cheque for distributions or to reinvest the earnings and get more units.

Many experts say that one of the prime advantages of mutual funds is the professional management they provide for your money.

That’s because the cost of mutual funds makes professional advice available to all Canadians, whether the amount they have to invest is large, small, or somewhere in between. In fact, 19% of mutual fund investors had less than $5,000 in financial assets when they first started using an advisor and 50% had less than $25,000^*.

With mutual funds, you’ll also benefit from economies of scale.

That’s because a mutual fund buys and sells large amounts of securities at one time, so its transaction costs are lower than what you would incur for securities transitions as an individual. Yet another benefit if you happen to be investing a smaller amount of money, because it allows you to participate through a ‘pooled’ approach. If you were trading stocks and bonds as an individual, it would cost a lot more.

Is Mutual Fund Really Profitable?

Mutual funds are considered relatively safe investments. However, mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high expense ratios charged by the fund, various hidden front-end, and back-end load charges, lack of control over investment decisions, and diluted returns.

High Annual Expense Ratios

Mutual funds are required to disclose how much they charge their investors annually in percentage terms to compensate for the costs of running investment businesses. A mutual fund’s gross return is reduced by the expense ratio percentage, which could be as high as 3%. However, according to fund manager Vanguard, industrywide expense ratios averaged 0.54% in 2020.

Historically, the majority of mutual funds generate market returns if they follow a relatively stable fund such as the S&P 500 benchmark. However, excessive annual fees can make mutual funds an unattractive investment, as investors can generate better returns by simply investing in broad market securities or exchange-traded funds.

Load Charges

Many mutual funds have different classes of shares that come along with front- or back-end loads, which represent charges imposed on investors at the time of buying or selling shares of a fund. Certain back-end loads represent contingent deferred sales charges that can decline over several years.

Also, many classes of shares of funds charge 12b-1 fees at the time of sale or purchase. Load fees can range from 2% to 4%, and they can also eat into returns generated by mutual funds, making them unattractive for investors who wish to trade their shares often.

Lack of Control

Because mutual funds do all the picking and investing work, they may be inappropriate for investors who want to have complete control over their portfolios and be able to rebalance their holdings on a regular basis.

Because many mutual funds’ prospectuses contain caveats that allow them to deviate from their stated investment objectives, mutual funds can be unsuitable for investors who wish to have consistent portfolios. When picking a mutual fund, it’s important to research the fund’s investment strategy and see which index fund it may be tracking to see if it’s safe.

Returns Dilution

Not all mutual funds are bad, but they can be heavily regulated and are not allowed to have concentrated holdings exceeding 25% of their overall portfolio. Because of this, mutual funds may tend to generate diluted returns, as they cannot concentrate their portfolios on one best-performing holding as an individual stock would. That being said, it can obviously be hard to predict which stock will do well, meaning most investors who want to diversify their portfolios are partial to mutual funds.

You can ascertain the safety of an investment in two ways:

• Security in terms of the company or institution where you have the investment running away with your money.
• Safety in terms of capital protection and fixed returns.

No one will run away with your money

If you are worried that mutual funds are a type of flight-by-night scheme, then rest assured that mutual funds are completely safe. You will not wake up one morning to find out that the mutual fund you have invested with has vanished along with your money. That is never going to happen! Why do we say this?

As mutual fund companies are regulated and supervised by regulatory agencies such as the Securities and Exchange Board of India (SEBI) and the Association of Mutual Funds in India (AMFI), no fund house can abscond with the investor’s money.

The license to run a mutual fund house is given after due diligence in a similar way as banks get the banking license. In short, a mutual fund house is as safe as a bank.

Mutual Funds are meant for earning higher, tax-efficient returns

Mutual funds don’t guarantee capital protection or fixed returns. However, this is a good thing as mutual funds would be a poor investment product if they did.

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The purpose of investing in mutual funds is to earn higher returns than what traditional investment options offer. These returns are the result of more extensive market exposure and professional management of the mutual funds.

Mutual funds are also more tax-efficient than traditional investments. Moreover, the twin benefits of inflation-beating along with tax-efficient returns make mutual funds the choice of investment for seasoned investors.

Short-term as well as long-term gains from mutual funds are taxed in a way that doesn’t eat into the returns. These funds make sense as long-term investments because the longer you stay invested, the more are the returns you earn.

This is because of the power of compounding benefit where your returns, in turn, make more returns. Over longer time periods, mutual funds have given superior returns that have beaten traditional investments and also been higher than the prevailing rate of inflation.

The risk that comes with mutual fund investments can be managed by diversifying your investments and investing based on financial goals, time horizon and risk tolerance.