Mutual Funds - Meaning and Features | Advantages and Disadvantages of Mutual Funds

There are various investments alternatives available for investors which are already discussed in my previous article. Out of these alternatives, mutual funds are now gaining popularity in our country. The main reason of this is that it offers many benefits to small and medium investors which are not available in other alternatives. Now take a look on complete concept of mutual fund.

Table of Contents

1. Meaning of Mutual Funds

2. History of Mutual Funds

3. Features of Mutual Funds

4. Advantages of Mutual Funds

5. Disadvantages of Mutual Funds

Meaning of Mutual Funds

In general term, a mutual fund is an investment vehicle for medium and long term investors where they can pool their funds for investing in a diversified portfolio with a view to earn decent return and appreciation in their value. The fund so collected is management by the professional fund managers so investors need not worry too much about their investment. Mutual fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. Through investment in a mutual fund, an investor can get access to equities, bonds, money market instruments and/or other securities that may otherwise be unavailable to them and avail of the professional fund management services offered by an asset management company.

SEBI defines mutual funds as “A fund established in the form of a trust to raise monies through the sale of units to the public or a section of the public under one more schemes for investing in securities, including money market instruments.”

So, a mutual fund is a special institution, a trust or an investment company which acts as a pure intermediary who collects funds from investors and channelizes the savings in a diversified portfolio of securities is such a way that investors can get steady returns and capital appreciation at a low risk.  

History of Mutual Funds

Though the concept of mutual fund is a new concept in Indian securities market, but it is not new for international security market. Mutual funds first established in the Dutch Republic in the year 1772-73. Its main aim was to provide small investors an opportunity to diversify their investments. But mutual funds get popularity when they are introduced in United States in 1890s. That time mutual fund institutions deals only in closed ended funds. Since there is a lack of liquidity in closed ended fund, investors didn’t want to block their money in closed ended funds in the early phase. But with the introduction of open-ended funds on 21st Mar, 1924, investors started to invest more money in mutual funds.

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank of India. The first mutual fund scheme was launched by UTI in 1964. Earlier private players are not allowed in mutual fund industry in India. But With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families.

Also Read :- Investment and type of  alternative investment

Mutual fund features and Benefits

There are certain key features of mutual funds:

Some of the important features of mutual funds in points are listed below:

1.       Mutual Fund Diversification: It is not possible for small investors to invest in variety of sectors. They mainly invest in few selected securities and rely on them for good return. An investor in a mutual fund gets the advantage of being invested in the entire fund’s portfolio which is invested in a diversified sector.

2.       Mutual Fund Professional Management: The mutual fund institution employs professionals to manage the pool of funds collected from investors. Most small investors can’t possibly spend their days researching individual stocks or bonds and market trends. By owning a fund, the investors can take advantage of the abilities of the fund’s management team.

3.       Small amount of investment: Investments in mutual funds can be started with small amount. Sometimes the initial investment may be as low as Rs.100, and subsequent investments into the fund may be made with similar small amounts.

4.       Mutual Fund Liquidity: Mutual funds are highly liquid. They are sold at their net asset value which is computed on every business day after the close of the markets. The price you receive depends on the value of the securities in the fund.

5.       Transparency: All the details relating to mutual funds investments are easily available online or one can get the complete details of his investment via mobile applications of their mutual fund institution.

6.       Savings habit: It creates a habit of systematic and regular investment amongst the investors.

Advantages and Disadvantages of Mutual Funds

Advantages of Mutual Funds

A mutual fund is a special type of institution which acts as an investment intermediary and channelizes the savings of large number of people towards the corporate securities in such a way that investors get steady returns and capital appreciation at low risk. Mutual funds are gaining popularity now days due to the following advantages:

1.       Professional Management: A small investor cannot be an expert in portfolio management so there is a chance of loss for small investors. Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. There are several aspects to such professional management viz. investing in line with the investment objective, investing based on adequate research, and ensuring that prudent investment processes are followed.

2.       Diversification: It is not possible for small investors to invest in variety of sectors. They mainly invest in few selected securities and rely on them for good return. An investor in a mutual fund gets the advantage of being invested in the entire fund’s portfolio which is invested in a diversified sector. Thus, even a small investment of Rs 5,000 in a mutual fund scheme can give investors a diversified investment portfolio.

3.       Economies of large Scale investment: The pooling of large sums of money from so many investors makes it possible for the mutual fund to engage professional managers to manage the investment. Individual investors with small amounts to invest cannot, by themselves, afford to engage such professional management.

4.       Liquidity: The most peculiar advantage of a mutual fund is that investments made in its schemes can be converted into cash promptly with incurring any heavy expenditure. As per the regulations of SEBI, is becomes necessary for every mutual funds institutions is to ensure liquidity for its investors.

5.       Tax Benefits: Mutual funds are not liable to pay tax on the income they earn. If the same income were to be earned by the investor directly, then tax may have to be paid in the same financial year. Specific schemes of mutual funds (Equity Linked Savings Schemes) give investors the benefit of deduction of the amount invested, from their income that is liable to tax. This reduces their taxable income, and therefore the tax liability.

6.       Low risk: Mutual funds invest in a diversified sector and these funds are managed by highly qualified professionals. So, risk factor is reduced which is not possible in case of direct investment by an individual.

7.       Higher return: Various reports now ensure that mutual funds are giving higher return with low risk as compared to other investment vehicles. But this is only possible when portfolio is well diversified and fund managers are efficient.

8.       Convenient Options: The options offered under a scheme allow investors to structure their investments in line with their liquidity preference and tax position. Mutual funds also provide switch option form one scheme to another scheme.

9.       Investment Comfort: Once an investment is made with a mutual fund, they make it convenient for the investor to make further purchases with very little documentation. This simplifies subsequent investment activity.

10.   Regulatory Comfort: The regulator, Securities & Exchange Board of India (SEBI) has mandated strict checks and balances in the structure of mutual funds and their activities. These are detailed in the subsequent units. Mutual fund investors benefit from such protection.

11.   Systematic approach to investments: Mutual funds also offer facilities that help investor invest amounts regularly through a Systematic Investment Plan (SIP); or withdraw amounts regularly through a Systematic Withdrawal Plan (SWP); or move moneys between different kinds of schemes through a Systematic Transfer Plan (STP). Such systematic approaches promote an investment discipline, which is useful in long term wealth creation and protection.

Disadvantages of Mutual Funds

In spite of various advantages, mutual funds suffer from various disadvantages some of which are listed below:

1.       Lack of portfolio customization: Mutual fund unit-holder is just one of several thousand investors in a scheme. Once a unit-holder has bought into the scheme, investment management is left to the fund manager. Thus, the unit-holder cannot influence what securities or investments the scheme would buy.

2.       Liquidity crisis: Mutual funds in India face liquidity problems. Investors are not able to draw back from some of the schemes due to lack of no easy exit route. Recently, we saw that Franklin Templeton has defaulted in redemption of mutual funds during lock down period.

3.       Choice overload: Over 1,200 mutual fund schemes offered by 38 mutual funds – and multiple options within those schemes – make it difficult for investors to choose between them.

4.       No control over costs: All the investor's moneys are pooled together in a scheme. Costs incurred for managing the scheme are shared by all the Unit holders in proportion to their holding of Units in the scheme. Therefore, an individual investor has no control over the costs in a scheme.

5.       High Management Fee: The Management Fees charged by the fund reduces the return available to the investors.

6.       Inadequate research: Most of the mutual funds in India suffer losses to lack of in-house research facilities. They mainly based their investment decision on external research which sometime causes loss.

7.       Diversion of Funds: There may be unethical practices e.g. diversion of Mutual Fund amounts by Mutual Funds to their sister concerns for making gains for them.

8.       Inadequate disclosures: There have not been timely and adequate disclosures of material information to the investors by the mutual funds in India.

9.       Lock-In Period: Many MF schemes are subject to lock in period due to which it is not possible for investors to withdraw funds as and when they need.

10.   Delay in grievance redressal: Due to large number of investors and few numbers of professionals in mutual funds, delay in redressal of investor’s grievances is quite obvious.

In spite of the above disadvantages of mutual funds, this alternative is considered to be best and most rewarding investment vehicle in present world.

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