28 Mar, 2025
5 mins read
Mutual funds have emerged as one of the most popular investment options in India. According to AMFI, the Assets managed by Mutual Fund Houses stood at ₹64.53 trillion as of February 28, 2025, which was a two-fold increase from the assets managed in 2020. Mutual funds offer diversification, professional management, and accessibility, making them an attractive choice for investors of all types. However, like any investment, mutual funds come with both advantages and disadvantages. This article provides a detailed overview of mutual funds, their benefits, drawbacks, and key considerations before investing.
A mutual fund is a pooled investment vehicle that collects money from multiple investors and invests it in a diversified portfolio of assets, such as stocks, bonds, commodities, or other securities. The fund is managed by professional fund managers, who make investment decisions to generate returns based on the fund’s objectives.
Mutual funds can be categorised based on their structure, asset class, and investment objective:
Based on Structure: Open-ended, closed-ended, and interval funds.
Based on Asset Class: Equity funds, debt funds, and hybrid funds.
Based on Investment Objective: Growth funds, income funds, tax-saving funds, etc.
When you invest in a mutual fund, your money is pooled with funds from other investors. The collective investment is then allocated across different securities based on the fund’s strategy. The performance of the fund depends on the value of the underlying assets. Investors receive units representing their share of the fund’s holdings, and the Net Asset Value (NAV) determines the price per unit.
Mutual funds provide multiple benefits that make them an attractive investment avenue. Here are the key advantages:
Mutual funds invest in a broad range of assets, reducing the impact of poor performance by any single investment. For instance, an equity mutual fund may spread its investments across various sectors like banking, IT, and healthcare, minimising sector-specific risks. A flexi cap fund can invest across market capitalisations which can add value to your overall investment portfolio and relieves you of the effort required in making separate investments.
Qualified fund managers handle mutual fund investments using in-depth research and analysis. This is beneficial for investors who lack the expertise or time to manage their portfolios actively.
Mutual funds allow investors to start with relatively small amounts. Systematic Investment Plans (SIPs) enable investors to invest as little as INR 500 per month, making them accessible to retail investors.
Most mutual funds, especially open-ended funds, offer high liquidity, allowing investors to redeem their units at any time. This is particularly useful in emergencies.
Equity-linked savings schemes (ELSS) provide tax deductions under Section 80C of the Income Tax Act, up to INR 1.5 lakh per year under the Old Tax Regime. Additionally, long-term capital gains (LTCG) tax on equity funds gets an exemption of up to Rs 1.25 lakh in any financial year, LTCG at 12.5% applies only for gains over Rs 1.25 lakh.
The Securities and Exchange Board of India (SEBI) regulates mutual funds, ensuring fair practices and investor protection. Regular disclosures on holdings, performance, and expenses enhance transparency and make it safer for investors.
Investors can choose from lump sum investments or SIPs, based on their financial goals and risk appetite.
By staying invested for the long term, investors can benefit from the power of compounding, where returns generate additional returns over time. For example, an investor who invests Rs 10,000 monthly in an equity mutual fund earning 12% annually can accumulate around Rs 1 crore in 20 years.
Despite their benefits, mutual funds have certain drawbacks that investors should consider:
Since mutual funds invest in market-linked securities, their value fluctuates with market conditions. For example, during a stock market downturn, equity mutual funds may witness a decline in value.
Mutual funds charge management fees, known as the expense ratio, which can reduce overall returns. The average expense ratio for equity mutual funds in India ranges between 1% and 2.5%.
A high expense ratio can significantly impact returns over the long term. For instance, if a mutual fund earns an annual return of 12%, but the expense ratio is 2%, the actual return for investors is reduced to 10%.
Unlike fixed deposits, mutual funds do not offer guaranteed returns. Even debt funds, which are considered safer, can be impacted by interest rate changes.
Some mutual funds impose exit loads if units are redeemed before a specific period. For example, an equity fund may charge a 1% exit load if redeemed within one year. ELSS funds have a mandatory three-year lock-in period.
While diversification reduces risk, excessive diversification can limit high returns. Holding too many assets can dilute the impact of well-performing investments.
Past performance does not guarantee future returns. Many investors assume that a fund with high historical returns will continue to perform well, which is not always the case.
Unlike direct stock investing, where you decide which stocks to buy or sell, mutual fund investors rely on fund managers. If the fund manager’s strategy does not align with your expectations, returns may be lower than anticipated.
While ELSS funds provide tax benefits, other mutual funds are subject to capital gains tax. Short-term capital gains (STCG) on equity funds (held for less than one year) are taxed at 15%, while long-term capital gains (LTCG) exceeding INR 1.25 lakh are taxed at 12.5%. Gains on debt mutual funds are taxed at your Income Tax slab.
Mutual funds are a versatile investment option that caters to various financial goals. They offer diversification, professional management, and tax benefits, but also come with risks and costs. Before investing, it is crucial to assess your risk appetite, financial goals, and fund performance.
A well-informed approach, combined with a long-term investment horizon, can help investors maximise the advantages while minimising potential downsides. Consulting a financial advisor or researching through trusted sources such as SEBI, AMFI, or reputed financial publications can further aid in making an informed decision.
Yes, mutual funds come with market risk, credit risk (for debt funds), and liquidity risk. However, selecting funds based on one’s risk tolerance and investment horizon can help mitigate these risks.
The key disadvantages include market risk, no guaranteed returns, expense ratios, exit loads, and lock-in periods. Investors should carefully evaluate these factors before investing.
Calculate your Net P&L after deducting all the charges like Tax, Brokerage, etc.
Find your required margin.
Calculate the average price you paid for a stock and determine your total cost.
Estimate your investment growth. Calculate potential returns on one-time investments.
Forecast your investment returns. Understand potential growth with regular contributions.
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