7 Advantages of Mutual Funds
To diversify is to reduce risk. For example, let’s say you buy milk from one milkman. If someday he falls ill, you won’t have any milk to drink! On the other hand, if you buy milk from two milkmen, If one falls ill, you’ll still have supply from the other.
The chance of both the milkmen falling ill at the same time is very low. This is why diversification is so important in investing as well.
The advantage of mutual funds is that diversification is automatically done. Instead of buying shares, bonds, and other investments on your own, you outsource the task to an expert.
2. Professional Management
Investing is obviously not an easy task. Investing, be it in shares, real estate, gold, bonds, and so on depends on a multitude of factors that constantly need to be studied and understood.
Many people often think they can understand the market. A great percentage of these people end up incurring a loss.
The advantage of mutual funds is that they are managed by professional experts. Thus, to ensure your money is invested in the right place, you have to choose the right mutual fund.
Once invested in a mutual fund, you can relax with the knowledge that an expert will make necessary changes to the portfolio whenever required.
This isn’t to say that you shouldn’t review your investments in mutual funds. If you’ve chosen your mutual fund carefully, reviewing it once a year is usually enough.
While investing, the availability of information and data is particularly time-consuming. If all the information would be easily available, investing would be much simpler.
In mutual funds, the research and data collection is done by the funds themselves. All you have to do is analyze the performance
Mutual fund dealers allow you to compare the funds based on different metrics, such as level of risk, return, and price. And because the information is easily accessible, the investor will be able to make wise decisions.
One advantage of mutual funds that is often overlooked is liquidity. In financial jargon, liquidity basically refers to the ability to convert your assets to cash with relative ease.
For example: If you want to sell your house, how long would it take for you to sell it and get the cash in hand? It would take you anywhere from a few weeks, to a few months.
Mutual funds are considered liquid assets since there is high demand for many of the funds. You can, therefore, retrieve money from a mutual fund very quickly.
Mutual funds are one of the best investment options considering the costs involved. If you hire a portfolio management service, you’ll typically be charged 2% to 3% of the total investment per year. They will also deduct a share from your profit.
Mutual funds are relatively cheaper and deduct only 1% to 2% of the expense ratio. Debt mutual funds usually deduct even lesser. Read more about expense ratio: click here to open in new tab.
6. Tax Efficiency
Mutual funds are relatively more tax-efficient than other types of investments. Long-term capital gain tax on equity mutual fund is zero, which means, if you sell your investment one year after purchase, you don’t have to pay tax.
For debt funds, long-term capital gains apply when you hold them for 3 years. To understand tax on mutual funds: click here.
Apart from this, there are certain classes of funds, called ELSS funds, that are exempt under section 80 C up to a limit of Rs 1.5 lakhs. Some important features of tax-saving funds are:
- It is a surrogate route to the direct stock market
- The minimum investment is Rs 500 per month
- It has a lock-in-period of only 3-years
- The returns are tax-free as well
To know more about tax saving funds: click here.
7. How to Select Mutual Funds
Mutual Funds are of different types – this allows investors to invest in particular types of funds, depending on their goals. Here are some examples
- +To park money for an extremely short term, you can invest in liquid funds like Kotak Floater Short Term
- +To invest money for a short-term duration like 1 to 3 years, you can invest in Ultra Short Term Funds (example – Franklin India Low Duration Fund) or Short Term Funds (example – HDFC Short Term Opportunities Fund)
- +For Long-term investing, you can invest in equity funds. In equity funds, one can choose from high-risk funds like mid cap and small cap funds to relatively less risky funds, like large-cap and diversified funds
- +Investors who want to adopt a middle approach can choose balanced funds. Example – HDFC Balanced Fund.