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Why you should invest in mutual funds? - Outside View by PersonalFN

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Why you should invest in mutual funds?
Apr 20, 2012

While everyone fantasizes about investing in the equity markets and is passionate about investing in stocks, what's more important is; how smartly are these investments done.

One can invest in the equity markets either through the direct route i.e. stocks or through the indirect route i.e. equity mutual funds.

Both have their own pros and cons, and so it is important for us to understand both routes before embarking on an investment spree.

If you as an investor have profound insightsabout stocks and investing, with the requisite time and skill to analyse companies, then you can surely begin independent stock-picking. But, in case if you lack any one or all these pre-requisites, then you will be better off by investing in stocks through the indirect route i.e. through equity mutual funds. Mutual funds offer several important advantages over direct stock-picking.

1. Diversification

Investing in stocks directly may lead to one serious drawback - lack of diversification. By putting your money into just a single or few stocks, you can subject yourself to considerable risk. Decline in a single stock can have an adverse impact on your investments, damaging the returns of your portfolio.

A mutual fund, by investing in several stocks, tries to overcome the stock specific risk or the risk of investing in just 3-4 stocks. By holding say, 30 odd stocks, the fund avoids the danger of one bad pick spoiling the whole portfolio. Mutual Funds own stocks, anywhere from a couple of dozen to at times over hundred stocks. A diversified portfolio may thus fall to a lesser extent, even if a few stocks fall dramatically. Also, a mutual fund's Net Asset Value (NAV) may certainly drop, but diversified mutual funds tend to not fall as freely or as easily as stocks. The legal structure and stringent regulations that bind a mutual fund do a very good job of safeguarding investors' interest.

2. Professional management

Active portfolio management requires not only sound investment sense, but also considerable time and skill.

By investing in a mutual fund, you as an investor do not have to track the prospects and potential of each company in the mutual fund portfolio. This is already being done for you, by skilled professionals appointed by the mutual fund houses, professionals whose job is to continuously research and monitor these companies.

3. Lower entry level

There are very few quality stocks today that you can buy with Rs 5,000 in hand. This is especially true when valuations are expensive. Sometimes, with as much as Rs 5,000 you can buy just a single stock.

In the case of mutual funds, the minimum investment amount required is as low as Rs 500. This is especially encouraging for investors who start small and at the same time get exposure to the fund's portfolio of 20-30 stocks.

4. Economies of scale

By buying and selling a handful of stocks, you are likely to lose out on economies of scale. This may directly impact the profitability of the portfolio. If you as an investorbuyor sell actively, the impact on profitability would be that much higher.

On the other hand, in case of mutual funds, timely voluminous purchases/sales results in proportionately lower trading costs than individualstocks, thus translating into significantly better investment performance.

5. Innovative plans/services for investors

By investing in equity markets through mutual funds, youcan take advantage of various innovative plans and convenience offered by fund houses.

For example, mutual funds offer automatic re-investment plans, systematic investment plans (SIPs), systematic withdrawal plans (SWPs), asset allocation plans, triggers etc., tools that enable you to efficiently manage your portfolio from a financial planning perspective too.

These features allow you to seamlessly enter/exit funds, or switch from one fund to another.

6. Liquidity

As an investor you may not always find the liquidity in a stock to the extent desired.There could be days when the stock is hitting an upper/lower circuit, thus curtailing buying/selling. Further, if you are invested in a penny stock, you may find it difficult to get out of it.

On the other hand, mutual funds offer some much required liquidity while investing. In case of an open-ended fund, you can buy/sell at that day's NAV by simply approaching the fund house directly, or by approaching your mutual fund distributor or even by transacting online.

As highlighted above, investing in mutual funds has some additional benefits that may not be always available while investing in stocks. However by no means are we insinuating that mutual fund investing is the only way of clocking growth. This can also be done even by investing directly into the right stocks. However, mutual funds offer the investor a relatively safer and better way of picking growth minus the hassle and stress that has become identical with stocks over the years.

On account of the aforementioned advantages which mutual funds offer, they (mutual funds) have emerged as immensely popular asset class, especially for retail investor, and for the investors looking for growth with relatively lower risks.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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1 Responses to "Why you should invest in mutual funds?"

Advantages of Mutual Funds

Apr 25, 2012

Mutual funds offer professional management to investors by pooling their money to buy a specific mix of investments and to focus on investment advisory service.The right mutual funds for you are largely the result of efforts by the managers and their daily portfolio decisions.

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