Mutual Funds are becoming a popular investment option nowadays. But while investing, you must be aware of the advantages and risks of mutual funds, so that you can choose a better fund for yourself.
Here are some important advantages and risks of mutual funds :
Advantages of Mutual Funds for Investors
There are several benefits from investing in a Mutual Fund:
Small investments: Mutual funds help you to reap the benefit of returns by a portfolio spread across a wide spectrum of companies with small investments.
Professional Fund Management: Professionals having considerable expertise, experience and resources manage the pool of money collected by a mutual fund. They thoroughly analyse the markets and economy to pick good investment opportunities.
Spreading Risk: An investor with limited funds might be able to invest in only one or two stocks/bonds, thus increasing his or her risk. However, a mutual fund will spread its risk by investing a number of sound stocks or bonds. A fund normally invests in companies across a wide range of industries, so the risk is diversified.
Transparency: Mutual Funds regularly provide investors with information on the value of their investments. Mutual Funds also provide complete portfolio disclosure of the investments made by various schemes and also the proportion invested in each asset type.
Choice: The large amount of Mutual Funds offer the investor a wide variety to choose from. An investor can pick up a scheme depending upon his risk/return profile.
Regulations: All the mutual funds are registered with SEBI and they function within the provisions of strict regulation designed to protectthe interestsof the investor.
Tax Benefits: You can avail lots of tax benefits while investing in mutual funds, like long-term capital gain tax on various mutual funds is zero, which means, if you sell your equity mutual fund investment one year after purchase and after three year in case of debt mutual fund, you don’t have to pay tax.
Not only this, there are also certain classes of ELSS funds, that are exempt under section 80 C up to a limit of Rs 1.5 lakhs.
Risks of Mutual Funds
Mutual Funds do not provide assured returns. Their returns are linked to their performance. They invest in shares, debentures, bonds etc. All these investments involve an element of risk. The unit value may vary depending upon the performance of the company and if a company defaults in payment of interes Vprinci pa l on their debentures/bonds the performance of the fund may get affected. Besides incase there is a sudden downturn in an industry or the government comes up with new a regulation which affects a particular industry or company the fund can again be adversely affected. All these factors influence the performance of Mutual Funds.
Some of the Risk to which Mutual Funds are exposed to is givenbelow:
Market risk: If the overall stock or bond markets fall on account of overall economic factors, the value of stock or bond holdings in the fund's portfolio can drop, thereby impacting the fund performance.
Non-market risk: Bad news about an individual company can pull down its stock price, which can negatively affect fund holdings. This risk can be reduced by having a diversified portfolio that consists of a wide variety of stocks drawn from different industries.
Interest rate risk: Bond prices and interest rates move in opposite directions. When interest rates rise, bond prices fall and this decline in underlying securities affects the fund negatively.
Credit risk: Bonds are debt obligations. So when the funds invest in corporate bonds, they run the risk of the corporate defaulting on their interest and principal payment obligations and when that risk crystallizes, it leads to a fall in the value of the bond causing the NAV of the fund to take a beating.
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