Importance of Mutual Funds

The demand for products facilitating investments has grown over time in search of a better lifestyle. Adding to it the depreciating value of the currency has forced investors to look at a diverse array of investment solutions which can help them grow their wealth. A convenient way to increase potential returns and gain access to financial markets is provided by mutual funds. This is also a reason why the importance of mutual funds is growing.

Mutual Funds “Sahi Hai”?

Mutual funds are created as baskets of investments, which invest in financial instruments like stocks and bonds according to their defined investment objectives. Investing in them allows an investor to gain access to asset classes like equities, bonds or fixed income securities, commodities, and even bullion.

These investment vehicles are created by fund companies under the aegis of an investment trust and are owned by investors who buy units or shares in them. They are pools of investment formed from the money invested by investors in exchange for units or shares. They are managed by an investment team with portfolio composition decisions being taken by a fund or portfolio manager. The manager, with the help of research analysts, decides which instruments, stocks or bonds, go into an investment portfolio or fund, and which need to be sold off.

Importance of Mutual Funds

Mutual funds provide a host of benefits which make them important. Let’s look at the importance of mutual funds as listed below.

Convenience: 

For investors, one of the most prominent benefits that mutual funds provide is convenience. By investing in a single fund, they can gain access to a broad range of the financial market. A typical diversified equity fund can spread out the money across tens of stocks with some portion invested in fixed income securities as well.

Diversification:

Further, if an investor wants to focus on one segment of the market, for instance, large-cap stocks, funds focused on this segment can spread out the investment across multiple large-cap stocks in just one transaction of purchasing the fund. If the investor were to try to do that themselves, it would take a lot of effort, transaction cost, and time to create an individual large-cap stock portfolio. The situation with investing in bonds is even more difficult if one tries to do it individually rather than taking the fund route.

Ease of Investment:

Apart from this, mutual funds are easy to buy and sell. One can either engage the services of a distributor or agent to transact in funds or do it over the internet themselves. In the case of latter, the transaction amount is debited from or comes directly to the bank account linked to the mutual fund account depending on whether a fund has been bought or sold.

Spoilt for Choice:

This feature follows from the convenience aspect discussed above. Investors have several choices when it comes to mutual funds. And given their investment objectives, funds provide access to a wide range of financial instruments, sectors, and strategies.

Professional Management:

This is one of the factors, which is a key highlight of the importance of mutual funds. Due to lack of expertise several investors don’t have the confidence in taking the financial market route to grow their wealth. They feel they have limited or no capability to invest in stocks and bonds on their own and do not have the time to keep tracking their investments even if they manage to invest on their own.

Mutual funds take care of this issue by providing the expertise of the fund manager and their team of analysts, which perform the analysis of financial markets and instruments on a daily basis. They charge a fee for their professional services, which are bundled into the expense ratio of a mutual fund.

Some fund managers also invest in the same fund(s) that they manage, thus making them accountable for their performance; they have a stake in the fund doing well. This expertise and experience in money management make mutual funds a great vehicle for investors.

This assumes a lot of importance for investors as by investing minimal time and energy, they can add a variety of instruments to their investment portfolio.

How Mutual Funds can Enhance Your Portfolio?

For instance, among equity funds, there are diversified equity funds, large-cap funds, mid-cap funds, and small-cap funds as it comes to market cap classification. Then there are aggressive funds, which focus on beating market returns by a wide margin, and balanced funds, which are hybrid in structure due to a sizable allocation to fixed income securities or bonds. There are also sector-oriented funds, which focus on companies from a particular sector like banking, pharmaceuticals, or technology, among others. There are thematic funds as well. Meanwhile, ELSS (Equity Linked Savings Schemes) are diversified funds with a lock-in period of three years and provide tax benefits.

On the fixed income side, there are funds, which invest in government bonds, corporate bonds, or both. Further, there are duration-oriented funds like short, medium, or long-term and dynamic bond funds. There are fixed maturity plans as well, which compete with bank and post office fixed deposits.

They Provide Portfolio Diversification:

Importance of mutual funds is not limited to just ample choice; while providing a vast array of choices, equity mutual funds also spread across their assets across various sectors and industries. If the fund is diversified, it also spreads its assets across market capitalizations. Apart from this, equity funds can invest some portion of their assets in bonds as well. This spreading out of assets is the basic concept underlying diversification.

Portfolio diversification can be achieved by buying individual securities as well. But with a limited corpus to invest, there are only so many stocks and bonds that an investor can buy. More so, there may be some bonds which may be out of reach of investors as the ticket size of a single purchase is very high. Meanwhile, mutual funds provide instant diversification.

There is a reason that diversification is so sought after. Let’s look at it in the next section.

Risk Mitigation and Management is the Key:

Systematic (or market) and unsystematic risk can cause investors to lose money in financial markets. The fear of losing their capital is what makes several investors hesitant to invest in markets. Though the systematic risk, i.e. the risk inherent in markets cannot be done away, mutual funds try to mitigate the unsystematic risk by utilizing portfolio diversification and professional management.

Managing risk and reducing it to an optimal level is one of the main tasks of the fund manager and their team of analysts. Diversification is helpful in this because once an investor’s money is spread across several sectors, industries, and market caps, the risk spreads out as well. If one sector or industry declines in value, other sectors, and industries can help counter the decline or at least soften the blow.

Let us look at a scenario wherein a fund’s portfolio, the banking sector was to decline and stocks from the sector form 20% of it.  Then the remaining80%, given their dynamic, can support the performance of the fund or reduce the decline caused by banking stocks. However, if an investor were to pick individual stocks instead of mutual funds, it is possible that more than half of his stock portfolio declines in value much higher than in case of the aforementioned example of a fund.