Below are key advantages of investing in mutual funds:
Professional Management: Mutual Funds are managed by professional fund managers who have a team of investment analysts performing thorough analysis of investment securities so as to carefully select securities and structure mutual fund portfolio. It may not be feasible for individual investors to perform such detailed analysis themselves and/or hire team of experts to manage their investment portfolio.
Diversification: Mutual funds invest in number of different securities so that there is diversification of financial risk. Thus, underperformance of a few securities is compensated by good performance of other securities which provides optimum risk adjusted returns to the investors.
Minimum investment: Investors can start investing in mutual funds even by committing very less amount of upfront funds. As investors accumulate surplus money, they could keep invest those in mutual funds.
High Liquidity: Investors can easily invest as well as redeem their investments as per their financial needs. The required quantity of mutual fund shares / units could be sold on stock exchange and the investment proceeds could be realised basis the applicable NAV.
Variety of funds: Mutual funds have a large variety of schemes in Equity and Fixed Income funds to suit investment objectives of different investors.
Below are few disadvantages of investing in mutual funds:
High fees: Mutual funds charge fees for professionally managing the investors pool of funds. These fees are referred to as Expense Ratio and vary for different types of funds usually ranging from 1 to 3 %. The expense ratio is low for Fixed Income Funds and high for Equity Funds. Expense ratio help manage commission & brokerage fees, advertising & marketing expenses and other operating expenses incurred by the mutual funds. However, these fees are easily compensated by superior fund returns.
Fund Performance: Although mutual funds publish past returns delivered by their schemes, there is no guaranteed returns on mutual fund investments. Depending upon the fluctuations of prices of stocks / securities the valuations of mutual funds fluctuate. Mutual fund investments especially those of equity mutual funds are prone to loss of principal amount as well in short term. However, mutual funds tend to deliver superior returns in the medium to long term as compared to traditional investment avenues providing fixed & assured returns.
Cash presence in portfolios: Mutual funds keep cash reserves to meet redemption requirements. Keeping such cash reserves effectively means keeping the funds idle and thus losing out on investment opportunity. Higher the cash reserve maintained by the mutual fund, higher would be the adverse impact on fund returns / performance. However, considering that various investors pool their money into the mutual funds, such cash reserves are required to fulfill their redemption requirements.
Difficulty in comparing funds: There are various mutual fund houses offering variety of schemes to the investors. It is difficult for the investors to evaluate the scheme performance in terms of risk, returns, expenses, investment portfolio, etc. and shortlist the schemes for investment. Hence, it may be recommended to consult your investment adviser to select best performing funds for your investments.
Lack of transparency in holdings: Mutual funds disclose the portfolio holdings only once a month. During the month, the mutual fund portfolio would undergo portfolio churning i.e. buying and selling of various securities. Such transaction level data is not disclosed by mutual funds and thus investors may not be able to evaluate the reasons for good or bad performance of the mutual funds that they have invested their money into. Mutual fund investors need to have a long term investment horizon. Hence, it is important to check portfolio holdings and track returns periodically.
Thus Mutual Fund Advantages majorly outweigh the Disadvantages!