Over the years, mutual funds have gained significant popularity with investors. But why are they so popular?

Mutual funds offer a hoard of benefits like immediate diversification, compounding returns, liquidity, customizability, SIP etc. Let’s see why mutual fund investment is beneficial for investors.

What Are Mutual Funds?

A mutual fund favoured is a way to invest in the money market. Typically, an asset management company (AMC) collects money from investors to invest in the market. The purpose is to create a diversified portfolio beyond what an average investor can build. They invest the pulled fund into bonds, stocks, debentures, and other assets to create an optimised risk-return portfolio. When investors invest in mutual funds, they get professional fund managers to buy securities for them.

The capital gain from the investment depends on the performance of the fund. The income generated gets distributed among participating investors based on calculated NAV value and after deducting a few expenses.

Market-linked equity funds invest in company stocks. But the risk is less than stock investment.

Mutual fund investments have several advantages and few disadvantages. One advantage is creating a low-risk, high return portfolio. It offers immediate diversification, which helps lowering risk factors. But at the same time, returns generated by mutual fund investment are higher than other investment types.

Active And Passive Mutual Funds

Investors have two choices in investing in mutual funds – active and passive. Fees and performance of the fund depend on whether the fund is actively or passively managed.

Passively managed funds align to a benchmark index and try to mimic its performance. Hence, they don’t require the active participation of fund managers. It results in lower overhead, meaning passively managed funds carry lower fees than actively managed mutual funds.

Passively managed funds are of two types.

Index funds

These funds are made of stocks and bonds listed in a particular index. Hence, they mirror the risk and return of the benchmark they follow. For example, if you have invested in a SENSEX index fund, and the index moves up by 4 percent on a particular day, your fund will also move up by the same percentage.

Exchange-traded funds

One can trade these funds like ETFs. ETF mutual funds offer immediate diversification and also lower minimum investment than index funds.

Actively managed funds need professional managers or a team to make investment decisions. These funds try to outperform the market and generate higher returns for investors. As a result, these carry higher overhead expenses.

Why are mutual funds so popular?

There are several advantages packed into mutual fund investment, apart from returns.

Diversification

We always talk about portfolio diversification during investment. But it is easier said than done. Mutual funds solve the problem by offering immediate diversification beyond the abilities of a general investor. The fund manager researches the market and creates a balanced portfolio that balances risk and returns to achieve optimal diversification.

A fund manager would simultaneously invest in high-volatility stocks and highly stable corporate and government bonds to create a balanced portfolio.

One caveat, however, is that one mutual fund might not offer enough diversification. Hence, you might have to invest in funds that invest in various sectors. It will protect your investment from economic cycles.

Liquidity

While investors invest in stocks, they can buy and sell securities an n-number of times without restrictions. Similarly, investing in open-ended mutual funds allows high liquidity. In open-ended mutual funds, investors can redeem stocks in the funds through a registered stockbroker. Hence, most mutual funds are as liquid as stocks. However, some funds may come with a lock-in like ELSS funds, which offers tax savings.

Customizability

Another important factor that added to the popularity of mutual funds is customizability. Based on your investment goals or risk tolerance levels are, there are ample mutual fund options per your needs. You can select high-risk, high-return equity funds or low-risk debt funds according to your convenience.

Systematic Investment Plan (SIP)

Mutual fund SIP allows investors to make fixed and regular payments towards an investment scheme. With SIP, investors don’t need to time the market.

The rule of thumb of stock investment proposes to enter the market when it is at the lowest to gain maximum when the price rises. Since it is nearly impossible to catch the market at its bottom, general investors can invest through all market conditions with SIP. Investors can begin with a minimum investment of Rs 500, whereas to earn a substantial return with a lump sum investment, one must invest a significant amount at one go. Besides, SIP also allows the benefits of rupee cost averaging and power of compounding to garner substantial returns over the long run.

One can select a SIP as per cash flow and as minimum or as maximum. If you earn a monthly salary, you can opt for a fixed SIP monthly or quarterly as per your budget and convenience.

Expert Management

In actively managed funds, professional fund managers buy and sell securities on investors’ behalf to work risk-return through different market conditions. For new investors, it is a boon since they don’t have to constantly worry about their investment or check the market for ups and downs.

Accessibility

Mutual funds are widely available. One can start investing in a mutual fund from anywhere in the world:

  • Banks
  • Brokerages
  • Registrars
  • Asset Management Companies (AMCs)
  • Online mutual fund platforms
  • Agents

One can directly invest in mutual funds without opening a Demat account.

Safe & Transparent

Mutual fund investment is safe. The new SEBI guidelines require the mutual funds to be colour-coded to indicate the level of risk associated with the fund. It makes the entire process secure and transparent even to new investors. One can now easily select funds based on investment goal and risk profile.

Mutual funds use three colours to indicate the risk level of the fund.

  • Blue indicates low risk
  • Yellow depicts the medium risk
  • Brown, high risk

Cost-Effective

Mutual funds collect funds from different investors then invest the corpus into a portfolio. Hence, the investment cost is lower than stock market investment, where you need to pay transaction fees on every transaction. The cost of managing the funds gets divided between investors, and the savings from low cost is distributed among investors.

Tax Savings

ELSS mutual funds offer tax benefits u/s 80C of the Income Tax Act up to Rs 1.5 lakh in a year. ELSS mutual funds deliver higher returns than PPF, EPS, and tax savings index and offer tax benefits.

Other mutual funds are taxable depending on fund type and tenure.

Lowest Lock-in

Equity-linked saving schemes have a lock-in period of three years, lower than the five-year lock-in period for FD, ULIPs, and PPF. Investors also have the option to remain invested even after the lock-in. SIP in mutual funds allows investors to select investment amount and tenure as per convenience, and there is no early withdrawal penalty like with other investment types.

Best SIP Plans for 2021

Here are the names of the ten top mutual funds for SIP, where you can invest according to your investment goals.

  • Axis Bluechip Fund
  • Mirae Asset Large Cap Fund
  • Parag Parikh Long Term Equity Fund
  • Kotak Standard Multicap Fund
  • Axis Midcap Fund
  • DSP Midcap Fund
  • Axis Small Cap Fund
  • SBI Small Cap Fund
  • SBI Equity Hybrid Fund
  • Mirae Asset Hybrid Equity Fund

Conclusion

Here are some pointers to recognise while investing in these mutual funds schemes. Before investing, learn about each category to find the best suitable one. The hybrid funds or the equity hybrid funds are ideal for newcomers in equity investment. These schemes allow 65 to 80 percent of the corpus in equities and the rest in bonds to generate higher returns. More aggressive investors who want to pocket extra profit by taking a higher risk can invest in mid-cap mutual fund SIP.

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