Benefits of Investing in Mutual Funds
Indian Mutual Fund industry has grown by leaps and bounds in the past two decades. Past decade itself has seen a 5-fold increase in the assets under management of the mutual fund industry.
Demonetization has given further impetus to people moving from creating non-financial assets in earlier times to financial ones now. Sensex and Nifty reaching their all-time high has given another reason for retail investors to start participating in the equity markets. Whether that’s the right thing to do, we’ll keep that discussion for a later post.
There are 42 Mutual fund houses (a.k.a Asset Management Companies) with more than 11000 schemes in existence. People have invested in these schemes based on past performance, marketing by fund houses, recommendation by brokers, friends and financial planners, etc. For first time investors, mutual funds provide the best mode of participation in equity markets than by investing in individual stocks based on tips from brokers, TV, newspaper, internet, etc.
The four main benefits which makes investing via mutual funds the best for the know-nothing investor are also the main reasons crisply described by John Bogle in his book “Bogle on Mutual Funds” for the success of the mutual fund industry, namely:
- Broad Diversification
- Professional Management
The first benefit of mutual fund investing is broad diversification of securities. Most of the studies
show that retail investors are generally under-diversified owing on an average 6 stocks. It might be OK for a qualified investor who has analyzed the companies and has fair degree of comfort in the
management to own a select few companies with sizeable portion in each. However, the same is not
true for the know-nothing retail investor who is trying his hands in the market or to simply put it,
Transaction cost of buying/ selling along with minimum lot size of shares to be bought for each
transaction might restrict the number of companies you own for the amount you have decided to invest. Suppose you wanted to invest five thousand rupees, owing 3 shares of reliance industries would exhaust that amount and diversification is far from achieved. However, if you wanted to invest in Nifty, you could have easily bought few units of Nifty Index fund for the same amount which gives you a well- diversified portfolio of India’s top 50 companies.
For Young investors with limited finances, mutual funds provide a medium to start investing for their
financial goals. Systematic Investment Plans (SIP) is also a great option wherein one can contribute small amounts monthly for their goals and wealth creation.
The second benefit of mutual fund investing is professional management. This is a great benefit given the fact you can take advantage of an expert who does the stock selection and supervision on your behalf. These investment professionals manage the fund strictly in accordance with the fund’s
investment objective and policies. For instance, if you invest in a balanced fund (which is the flavor of the season these days!), you’ll be promised that a highly diversified list of blue chip stocks will comprise more than 65% of the portfolio and the balance will comprise of high grade bond and money market instruments. The professional manager has an obligation to meet these standards under all circumstances. All people waiting for their houses from the builders would so much want this to be true for the commitments given by the builder to them!
Professional management does not guarantee superior returns than the market because overall,
everyone will on average earn the market returns only. The one with the least expense ratio will give
the best returns, and that’s why investors should go the passive route by investing in Index Funds. Till the time index funds don’t get their due share, we should give credit to mutual fund houses to bring people to equity investing and thus get good returns on all their advertising and investor education initiatives by means of charging a higher expense ratio in all their actively managed funds. In nutshell, they instill financial discipline in one’s investing and monitoring of portfolio.
The third very important benefit of mutual fund investing is Liquidity. Mutual fund units can be
bought and sold at a click of a button/ call to your broker at the closing net asset value (NAV) per unit. If you are invested in markets directly, you have the advantage of trading throughout the day at the cost of market impact wherein buying securities tends to drive prices higher and selling securities tends to push prices lower. Mutual funds also offer the flexibility of switching between funds which doesn’t incur any cost apart from the exit load if you’re exiting before the stipulated lock-in period. In case of direct investing in markets, both buying and selling would incur a brokerage charge eroding your investment by that much amount.
The fourth benefit of mutual fund investing is also the main reason for the success of mutual funds,
Simplicity and Convenience. Convenience of mutual fund ownership starts from the first purchase
which makes you the owner of a diversified portfolio of stocks and bonds, followed by automatic
reinvestment of dividends, systematic periodic investments, systematic withdrawals, switching among funds, reporting the fund performance monthly and availability of customer support to address all your queries. These all are absent in case you wish to do it on your own by investing directly in stock market.
Lastly, since all mutual funds are highly regulated, you can invest and withdraw your money at a
moment’s notice without any fear that anyone can run away with your money.
Now it’s time to get into action and start Investing.