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Most investors think replicating a mutual fund portfolio and creating their own portfolio with the same stocks is quite easy. It is the greatest misconception ever. Trying to replicate the fund’s portfolio and aim to generate similar returns is next to impossible. Mutual funds are managed by experts (professional fund managers) who constantly track the markets and are quick with their investment decisions. The costs involved in acquiring individual stocks are also higher compared to investing in mutual funds. Read along to know the advantages of investing in mutual funds over equities.
Risk Diversification
Since portfolio diversification is one of the most important financial principles, mutual funds can be a simple and effective way to achieve this objective. They invest in a variety of companies across industries and sectors.
Risk Diversification is one of the advantages of mutual funds. There are three categories of risk associated with every stock: company risk, industry/ sector risk, and market risk. Company and industry risk are unsystematic risks, whereas market risk is systematic.
Mutual funds assist investors in diversifying their exposure to unsystematic risks by investing in a varied portfolio of companies from various industries. Mutual funds are solely vulnerable to systematic risk or market risk, but individual equities are subject to both unsystematic and systematic risks.
This diversification decreases risk because not all equities will experience losses simultaneously and in the same proportion. In other words, during volatile scenarios, a couple of stocks may lose their value while others may gain.
Returns
Stocks have the potential to generate higher returns. However, at the same time, they can lose value in no time. The prices are highly volatile and fluctuate drastically. On the other hand, since mutual funds invest in a diversified portfolio, the price fluctuations are not very high. Furthermore, due to diversification, a mutual fund’s stability in returns is greater . Thus, mutual funds have the potential to generate greater returns over the medium to long term since they invest in a diverse portfolio of carefully picked securities.
Small Ticket Size
One of the major advantages of investing in mutual funds is that you can begin investing with small amounts. To develop a diverse stock portfolio themselves, investors will need to invest a substantial amount of capital.
On the other hand, mutual fund investors can acquire a good diverse portfolio of stocks with considerably smaller investments. Investors can purchase units of a diversified equity mutual fund with as little as INR 1,000 to INR 5,000.
Expert Fund Management
Investing in stocks needs a significant amount of knowledge and experience. You must have an understanding of financial markets, industrial sectors, specific companies, and research skills. The greatest advantage of investing in mutual funds is that professional experts manage the investment portfolio. These managers possess the requisite education, expertise, and experience in selecting the finest stocks and other instruments to achieve the highest risk-adjusted returns. The fund managers are supported by a specialized investment research team that evaluates the performance and prospects of firms and chooses suitable assets.
Lower Transaction Costs
Economies of scale result in lower transaction costs, which is another advantage of mutual funds. Since mutual funds buy and sell enormous amounts of securities, the transaction fees per unit are far lower than those that individual investors face when buying or selling shares through stock brokers. Thus, mutual funds are one of the low-cost investment options.
Multiple Investment Options: Equity, Debt, Balanced/ Hybrid
Mutual funds provide investors with a selection of products that correspond to their investment objective and risk profile. There are equity funds, hybrid funds, debt funds, liquid funds, tax savings plans, etc., to accommodate various investment needs. The benefit of investing in mutual funds is the ability to invest in a product that meets your personal demands and risk tolerance.
You can choose a mutual fund strategy that closely matches the investment objectives you have in mind based on your risk tolerance and investment horizon.
Mode of Investment: SIP or Lumpsum
Mutual funds offer great flexibility in terms of the investment amount, mode of investment and withdrawal methods. You can choose between lump sum investment, systematic investment plans (SIP), systematic transfer plans (STP), and systematic withdrawal plans (SWP). Thus, depending on your financial goals, you can pick a suitable mode of investment. SIPs are a disciplined way of investing that helps you save regularly. Thus, compared to stock investing, mutual funds are more pocket friendly for investors.
Disciplined Investing
Mutual funds enable investors to invest a fixed amount regularly over a long duration, which is crucial for wealth creation. In addition, systematic investment plans (SIPs) for mutual funds help you remain disciplined in pursuing your financial objectives. Many individuals fail to create a sizable investment portfolio because they lack the discipline to invest. Thus, mutual fund SIPs assist clients in maintaining a disciplined investment routine.
SIPs also assist in overcoming the emotions from the investment process since many of us frequently become overly enthused during bull market situations and anxious during bear market conditions. It is a well-established fact that investments made in bear markets result in significant long-term returns. By contributing automatically through SIPs, you may maintain discipline and average out their costs, which is one of the greatest advantages of investing in mutual funds.
Convenience
Compared to investing in stocks, investing in mutual funds is incredibly convenient. Individual stock investing requires extensive research and monitoring.
Individual stock research and monitoring of corporate outcomes, management actions, share pledge data, etc., requires a great deal of effort and specialized knowledge.
On the other hand, investment in mutual funds is quite convenient, and periodic tracking at a high level may be sufficient to provide steady and relatively secure returns.
Liquidity
Open-ended mutual funds are one of the most liquid investments, second only to bank deposits, and significantly more liquid than investments such as life insurance policies, infrastructure bonds, and postal schemes, among others. Typically, investors can redeem their units in open-ended funds T+3 days.
Ultra-short funds, overnight, liquid, and low duration, can typically be redeemed on T+1. Mutual funds offer superior liquidity compared to other investment options such as life insurance plans (which have policy surrender fees) and government modest savings programmes (which have fixed maturity periods).
Suppose you need to sell 40% of your holdings to meet a financial obligation; you do not need to decide which stocks to sell and which to keep. Simply place a sell order to liquidate 40% of your mutual fund holdings.
Some small-cap companies may be relatively illiquid. It may be challenging to sell them at the current market price. Mutual funds are not susceptible to this problem.
Transparency
Transparency is another benefit of mutual funds for retail and HNI investors. The Net Asset Values (NAVs) of mutual fund schemes are disclosed at the end of each business day. Thus investors can track the daily market value of their mutual fund units. Furthermore, asset management companies provide monthly Fund Factsheets that detail the portfolio holdings for each mutual fund scheme. In addition to holdings, monthly fund factsheets contain helpful information such as returns relative to the scheme’s benchmark, risk ratios, etc.
Tax Benefit
One of the greatest advantages of investing in mutual funds, as opposed to many traditional fixed-income investments, is the tax advantage. Short-term capital gains (where the investment holding period is less than 12 months) are taxed at 15% on equities funds. On the other hand, long-term capital gains (where the investment holding period is more than 12 months) are tax-exempt up to INR 1 lakh in a fiscal year, and the excess capital gains are taxed at 10% thereafter.
Short-term capital gains (where the investment holding period is less than 36 months) in non-equity funds are taxed at your income tax slab rate. While long-term capital gains (where the investment holding period is more than 36 months) are taxed at 20% after indexation advantages.
Investments in ELSS mutual funds up to INR 1,50,000 qualify for tax deduction under Section 80C of the Income Tax Act, 1961. On the other hand, stock investments offer no such tax benefits to investors.
