Definition: The Mutual Funds are the professionally managed investment companies that pools the resources of several investors who shares the common financial goal. The funds so collected is reinvested by the fund manager into different types of securities ranging from shares to debentures to money market instruments depending upon the objective as stated in the mutual fund scheme.
The mutual fund’s prime advantage is that it enables the investors to invest in the diversified asset portfolio at a relatively lower cost. The fund manager attempts to structure the portfolio in such a way that it results in the maximum yield for the investors.
The advantages and disadvantages of mutual funds depend on the type of scheme taken by the investors. Hence, there are several mutual fund schemes, as listed below:
- Balanced Funds
- Equity-Diversified Funds
- Equity Linked Savings Scheme
- Sector Funds
- Thematic Funds
- Arbitrage Funds
- Hedge Fund
- Exchange Traded Funds
Advantages of Mutual Funds
- The investor is allowed to invest in the diversified portfolio in return for a mere management fee, which he pays to the fund manager who buys the different types of securities Viz. Shares, debentures and other money market instruments. Thus, the mutual funds allow the small investors to invest their funds in the diversified portfolio at a relatively lower cost.
- The returns in the form of dividend or interest received from the investments can be further used to purchase the additional shares in the mutual funds, thereby enabling the investors to grow their investments.
- Mutual funds help in reducing the portfolio risk through diversification. Since the fund manager invests in several securities of different companies or industries, an investor is protected against the risk of a huge monetary loss due to the problem in any one security.
- The assets in the portfolio are liquid, which means the investor can anytime convert its securities into cash by selling it to any other investor in the mutual fund.
- The inexperienced investors who do not know much about the securities and are looking for maximizing their financial goals can invest in the mutual funds to get their resources managed professionally.
- The investors can buy the mutual funds easily and with a minimum investment. These are traded once in a day thereby eliminating the price fluctuations throughout the day and discouraging the arbitrage opportunities that the day traders practice.
Disadvantages of Mutual Funds
- The cost associated with the mutual funds might be high as compared to the returns they produce. This is because the investor has to pay the commission along with the price of the mutual fund to the portfolio manager.
- The mutual fund returns like any other investments are uncertain and depends largely on the expertise of the fund manager. Thus, the capital gains extensively rely on the skill sets of the fund manager.
- Sometimes, the stock index outperforms the mutual funds and therefore, the investor must research all the fund related facts before investing in the portfolio.
- The management fee that shall be charged depends on the type of fund purchased. In a case of the riskier and aggressive funds, the management fee is considerably higher than the moderate risk funds.
Thus, an individual selects the investment scheme with an objective to diversify their portfolio risk and carefully study all the advantages and disadvantages associated with it in order to make an optimum choice.