Mutual Funds - Advantages and Disadvantages

 Mutual Funds

Mutual funds are investment vehicles which consist of a portfolio of stocks, bonds or other securities. They give small or individual investors a chance to get their money invested in a professionally managed diversified portfolio for low prices. Unlike stock, mutual funds do not give its holders any voting rights. A share of a mutual fund represents holdings in many different stocks or securities instead of just one security. Thus, what is actually being bought is a share of a portfolio. Next, let us talk about the advantages and disadvantages of mutual funds.

Advantages of Mutual Funds

  1.  Liquidity: Unless you opt for close-ended mutual funds, it is relatively easier to buy or exit a mutual funds scheme as compared to most other securities. You can sell your units at any time. It is however necessary to keep an eye on surprises like exit load or pre-exit synergy.
  2. Diversification: Due to the market risk involved in mutual funds, the fund manager always invests in more than one asset class (debentures, bonds, stocks, etc.) to spread the risks. This is known as diversification. As a result, whenever an asset class performs poorly, others can compensate with higher returns to avoid loss for investors.
  3. Expert Management: A professional manager handles the fund – hence investment in mutual funds gets you the management of an expert for the portfolio you have invested in. You also do not need to waste time in research as to asset allocation. Thus, the fund manager’s reputation should be an essential criterion in choosing which mutual fund to invest in.
  4. Lowered costs: You can check the expense ratio of different mutual funds and pick whichever best fits your budget. Expense ratio is the fee for managing the fund and it can be used to measure performance. You can even pick zero-load mutual funds with fewer expense ratios. Bulk transactions also result in lowered processing fees and other commission charges as compared to when you buy one unit at a time. 
  5. Various types of mutual funds: There are various types of mutual funds available in India catering to all types of investors from all walks in life. It is easy to find a mutual fund which matches your income, expenditure, investment goals and risk appetite.

Disadvantages of mutual funds

  1. No control: All mutual funds are managed by fund managers, sometimes supported by a team of analysts. As a result, you do not have any control over your investment – all decisions are made by the fund managers.
  2.  Management abuses: Churning, window dressing and turnover may happen if your manager is abusing his or her authority. This includes unnecessary trading, excessive replacement and selling the losers prior to the quarter-end to fix the books.
  3.  Dilution of profits: While the diversification averages your risks of loss, it can also dilute your profits. Hence, you should not invest in more than seven or nine mutual funds at a time.
  4. Lock-in periods: Many mutual funds have long-term lock-in periods, ranging from five to eight years. Thus, exiting such funds before maturity can be an expensive affair. A specific portion of the fund is always kept in cash to pay out to an investor who wants to exit the fund and this portion cannot earn interest for the investors.