What are mutual funds? What are the benefits and risks associated with investing in them?

mutual funds

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It’s crucial to make appropriate investment decisions to improve your financial future. Many people who invest in mutual funds need help or clarification about how to invest money. Depending on your ability to pay, you can invest via a Systematic Investment Plan (SIP) or make a lump sum contribution in a mutual fund.

Making the appropriate investment choice is essential to enhance your financial future. Choosing the right investment strategy is vital to prevent overtaxing your present.

So, what are mutual funds?

A mutual fund is an investment vehicle that pools in money from many different sources and uses it to buy bonds, equities, and other types of short-term debt fund. A mutual fund’s portfolio is set up and kept up to date following the specified investment goals in the prospectus.

The expense ratio is the cost to you as an investor that the AMC levies for managing the fund. It is not a set charge and differs from mutual fund to mutual fund.

How to invest in mutual funds?

  • Know your risk tolerance and risk capacity. Risk profiling is determining the level of risk you are willing to accept.
  • A properly filled-out application form and a check or bank draught should be brought to the branch office, designated Investor Service Centers (ISC), or Registrar & Transfer Agents of the specific mutual funds to invest in them. You may also invest online through various platforms.
  • Follow-ups and diversification are crucial to guarantee you get the most out of your investment.

Benefits of mutual funds 

Risk diversification: Three different categories of risks, including business, sector, and market risks, can affect any investment. Unsystematic risks include company and sector hazards, whereas systematic risks include market risks. Mutual funds invest in several businesses operating in numerous industries and sectors. This enables the fund to diversify the portfolio’s unsystematic risk.

Liquidity: Most mutual funds lack lock-in structures and are typically categorised as liquid investments. Additionally, the funds are well-integrated into the banking system, enabling a direct transfer of funds to your bank account.

Tax benefits: Section 80C of the Income Tax Act of 1961 allows for a tax benefit on investments in ELSS up to Rs. 1,50,000. Mutual fund investments are tax efficient when kept for a longer period.

Cost-efficiency: The expense ratio of several mutual funds can be compared, and the lowest expense ratio should be chosen. The management charge is reflected in the cost ratio of your mutual fund.

Small investments: You can spread your mutual fund investments over time by making smaller deposits in mutual funds, starting as low as Rs 500 for every SIP instalment. You lower the average investment cost by extending your investment over lows and highs in the stock market.

Risks of mutual funds

Exit load: When you withdraw money from any types mutual fund, AMCs charge exit loads as fees. It deters you for a while from selling investments. This functions like the lock-in period that fund companies employ to maintain the stability of the funds. Additionally, it aids the fund manager in obtaining the necessary capital for the timely and accurate acquisition of good assets.

Costs to manage the fund: Along with the fund’s operating expenses, a mutual fund’s additional charges also include the market analysts’ and fund managers’ salaries. All of this adds up to the total cost of managing the fund, thus impacting your returns.

Final note

Mutual funds stand out partly because they don’t subscribe to the “one size fits all” idea. By creating a wise investment strategy and doing your bit to research before investing, mutual funds tend to help your financial objectives as per your risk appetite.

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