5 min read • Published 19 Feb 25
Advantages and Disadvantages of Mutual Funds
Table of Contents
Investing in mutual funds is accompanied by its own set of advantages and disadvantages. They provide indirect market exposure, diversification and low-cost entry while being beginner-friendly. However, due to these characteristics, they face market pressure, complex taxation, lack of control, etc.
Therefore, understanding these varied aspects to make an informed decision is crucial for investors. Balancing the disadvantages and advantages of mutual funds can potentially help in the same.
Mutual Fund Investing
A mutual fund is a pooled investment which provides exposure to assets like stocks, bonds, debentures, etc., in a scheme based on its category. It is rapidly gaining popularity in India. As of November 2024, the industry’s Asset Under Management (AUM) has crossed ₹68 lakh crore. There are nearly 22 crore mutual fund folios.
Investors are highly inclined toward its benefits. However, there are some disadvantages of mutual funds that should be considered before investing. Evaluating these criteria can help investors analyse their investment in mutual funds.
Advantages of Mutual Funds
The basic nature and characteristics of these instruments are suitable for retailers in many ways.
- Market exposure
It provides indirect exposure to varied markets like the stock market, debt market and money market. However, its pooled investments distribute the risk. Moreover, investors get this exposure at a comparatively low cost and risk in the actual asset market.
- Affordability
One of the key characteristics or advantages of mutual funds is its low investment barriers. The facility of Systematic Investment Plans (SIPs) further allows investors to make investments every month. At such a low cost, investors will get exposure of multiple assets under one scheme. Retailers are highly benefited with this feature.
- Reduced risk
The indirect market exposure reduces the total risk of an investment. Moreover, due to more than one type of instrument in the scheme, this risk is balanced. It encourages investors to invest a significant amount.
- Low-cost maintenance
The schemes charge annual expenses, and it is deducted from the investor’s funds. It is known as Total Expense Ratio (TER) and is indicated in %. The Securities Exchange Board of India (SEBI) has prescribed a maximum limit for these charges. This expense may be spanned from 0.8% to 2.25%.
- Diversification
It is a crucial feature that investors aspire to in their investments. There are mainly four mutual fund categories:
- Equity: Investing in equity shares. There are different equity schemes based on the tenure, sectors, etc.
- Debt: These schemes invest in bonds, money market instruments and other debt instruments.
- Hybrid: These schemes are an amalgamation of equity and debt securities.
- Others: There are varied types of schemes such as gold funds, fund of funds, international funds, etc.
Therefore, a scheme may have investments in more than one asset, which will be managed by a professional fund manager.
Disadvantages of Mutual Funds
Along with different benefits, mutual funds also have some drawbacks. Investors should consider these before investing or allocating a major part of their portfolio.
- NAV fluctuation
Based on the category, a scheme may have majority exposure in an asset. Due to this, the Net Asset Value or NAV of an investment may fluctuate with market pressure, government policies, natural accidents, etc.
For example, when the central bank changes interest rates to regulate the money supply in the country, its direct effect is visible on the debt funds. Increase in interest rates, reduce the NAV and vice versa.
- Exit load
It is a special conditional charge by fund houses. According to it, when an investor redeems his/her units before a prescribed period, a % charge is imposed on this redemption. It discourages short-term investments. However, liquid funds are an exception to this charge.
- Tax implications
The tax is charged in two ways in a mutual fund transaction: on dividend income and during redemption. The dividend is taxed at 10% Tax Deducted at Source (TDS), and at the time of redemption, the tax applicable on the transaction will be as follows:
| Particulars | STCG* | LTCG* |
| Equity Funds | 20% (Holding = 12 months or less) | 12.5% (Holding = more than 12 months)Exemption for gains up to ₹1.25 lakhs |
| Specified Mutual Funds (investing 65% or more in Debt and Money Market Assets) | At investor’s income tax slab rate (no specific holding period) | At investor’s income tax slab rate (no specific holding period) |
| All Other Funds (not included in the above categories) | At the investor’s income tax slab rate (Holding = 12 months or less) | 12.5%(Holding = more than 12 months) |
* The tax rates are applicable for resident individual investors and the transaction on or after July 23, 2024.
Source: Association of Mutual Funds in India
- Lack of control
Mutual funds are managed by professional experts as fund managers. Investors are not liable for any decision, such as fund allocation. Therefore, they have less control over these activities. It may discourage investors with potential market knowledge.
- Liquidity
Some mutual fund categories and schemes have a compulsory lock-in period, such as that of 3 years. Moreover, there is a risk of some market instruments becoming illiquid. It can potentially block the investor’s funds.
However, the disadvantages of mutual funds can be managed by analysing investment properly before allocating funds. A potential fund house, fund manager, schemes and assets may manage these drawbacks efficiently.
Conclusion
The advantages and disadvantages of mutual funds demand the keen attention of investors. Some of its common benefits are affordability, low risk, low cost, diversification, etc. However, investors should also consider disadvantages such as taxation, exit load, NAV fluctuation and low control. Analysing the quantitative and qualitative details of an opportunity may help investors manage the same. Are you planning to start your financial journey? Log in to the PowerUp Money or download the financial management app today!
Q: What are the disadvantages of SIP?
A common drawback in SIP investments is that fluctuating NAV can affect the number of units received. In this fluctuating NAV, investors may miss the market gains. Moreover, it creates a monthly obligation for investors.
Q: How does interest rate change affect debt mutual funds?
Changes in interest rates and bond prices are inversely related, which directly affects the debt funds. Therefore, when interest rates increase, the debt fund NAV may fall and vice versa the case.
Q: Can mutual funds help in wealth creation?
Yes, mutual funds can be a potential option for investors to invest with different outlooks and create long-term wealth. It offers a wide range of categories for investment. It is also a suitable investment source with moderate risk and market exposure for investors.
Q: Are mutual funds better than stocks?
There is no definite comparison between these two investment products. It depends on an investor’s risk appetite. Investors with a risk-averse attitude may find mutual funds suitable due to their indirect exposure and professional management. However, investors with higher risk-return aspirations will opt for stocks.
Q: What is the exit load in mutual funds?
The % charged as a penalty by fund houses for early exit from mutual funds is known as exit loads. It helps promote long-term investments in the market.
