Why Should You Invest in Mutual Funds?
When considering investment opportunities, the first challenge that almost every investor faces is a plethora of options. From stocks, bonds, shares, money market securities, to the right combination of two or more of these, however, every option presents its own set of challenges and benefits.
So why should investors consider mutual funds over others to achieve their investment goals?
Mutual funds allow investors to pool in their money for a diversified selection of securities, managed by a professional fund manager. It offers an array of innovative products like fund of funds, exchange-traded funds, Fixed Maturity Plans, Sectoral Funds and many more.
Whether the objective is financial gains or convenience, mutual funds offer many benefits to its investors.
Mutual Funds help investors generate better inflation-adjusted returns, without spending a lot of time and energy on it. While most people consider letting their savings ‘grow’ in a bank, they don’t consider that inflation may be nibbling away its value.
Suppose you have Rs. 100 as savings in your bank today. These can buy about 10 bottles of water. Your bank offers 5% interest per annum, so by next year you will have Rs. 105 in your bank.
However, inflation that year rose by 10%. Therefore, one bottle of water costs Rs. 11. By the end of the year, with Rs. 105, you will not be able to afford 10 bottles of water anymore.
Mutual Funds provide an ideal investment option to place your savings for a long-term inflation adjusted growth, so that the purchasing power of your hard earned money does not plummet over the years.
Backed by a dedicated research team, investors are provided with the services of an experienced fund manager who handles the financial decisions based on the performance and prospects available in the market to achieve the objectives of the mutual fund scheme.
Mutual funds are an ideal investment option when you are looking at convenience and timesaving opportunity. With low investment amount alternatives, the ability to buy or sell them on any business day and a multitude of choices based on an individual’s goal and investment need, investors are free to pursue their course of life while their investments earn for them.
Probably the biggest advantage for any investor is the low cost of investment that mutual funds offer, as compared to investing directly in capital markets. Most stock options require significant capital, which may not be possible for young investors who are just starting out.
Mutual funds, on the other hand, are relatively less expensive. The benefit of scale in brokerage and fees translates to lower costs for investors. One can start with as low as Rs. 500 and get the advantage of long term equity investment.
Going by the adage, ‘Do not put all your eggs in one basket’, mutual funds help mitigate risks to a large extent by distributing your investment across a diverse range of assets. Mutual funds offer a great investment opportunity to investors who have a limited investment capital.
Investors have the advantage of getting their money back promptly, in case of open-ended schemes based on the Net Asset Value (NAV) at that time. In case your investment is close-ended, it can be traded in the stock exchange, as offered by some schemes.
Higher Return Potential
Based on medium or long-term investment, mutual funds have the potential to generate a higher return, as you can invest on a diverse range of sectors and industries.
Fund managers provide regular information about the current value of the investment, along with their strategy and outlook, to give a clear picture of how your investments are doing.
Moreover, since every mutual fund is regulated by SEBI, you can be assured that your investments are managed in a disciplined and regulated manner and are in safe hands.
Every form of investment involves risk. However, skilful management, selection of fundamentally sound securities and diversification can help reduce the risk, while increasing the chances of higher returns over time.
Different 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.
Active vs passive management
Active management means that the portfolio manager buys and sells investments, attempting to outperform the return of the overall market or another identified benchmark. Passive management involves buying a portfolio of securities designed to track the performance of a benchmark index. The fund’s holdings are only adjusted if there is an adjustment in the components of the index.
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.
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.
Before you invest, understand the fund’s investment goals and make sure you are comfortable with the level of risk. Even if 2 funds are of the same type, their risk and return characteristics may not be identical. Learn more about how mutual funds work. You may also want to speak with a financial advisor to help you decide which types of funds best meet your needs.