Mutual funds act as a convenient means of investing in two basic financial asset classes – stocks and bonds.
The advantages of investing money via Mutual funds are:
1. Broad diversification
2. Professional management
3. Liquidity
4. Simplicity & Convenience
Broad diversification – For a broad range of investors, investment corpus and cost alone prevent them to achieve adequate diversification without using mutual funds.
for example, you have 50,000 to invest, you can achieve diversification by purchasing 10 different stocks. However, the transaction costs incurred in buying and selling these individual stocks will be high since you have to do separate transaction for buying or selling each stock.
In bond funds the diversification offered by mutual funds is much more beneficial, since here you have minimum investment amount in individual bonds, if you have to achieve a diversification you need a big corpus.
If you are a young investor with limited disposable income to put towards investment purposes, the ability to diversify among stocks & bonds via mutual funds is a significant advantage.
Professional management – Investment professional who manages the mutual fund does it strictly in accordance with the fund’s basic investment objective and policy. Therefore, it is very essential that you read the investment objective of MF that you want to invest in.
Professional management does not promise you superior performance, rather it promises to outpace its peers. In sum, the collective performance record of professional managers strongly suggests that you might consider simply owing the market via an index fund, at least for your core investment philosophy.
Liquidity – You can liquidate your MF holdings anytime you want. The benefit over individual stock is you can liquidate at a lower cost than you would incur in selling individual securities since you have to engage in multiple transactions. You can also effectively switch among different investment options.
Simplicity & Convenience – Convenience of online buying, automatic reinvestment of dividends, reporting profits for tax, distributing gains, SIP, etc are big advantages.
The advantages are as usual followed by some disadvantages
1. It depersonalizes relationship between client and adviser
2. It comes with remarkable range of costs, some direct (expense ratio) and mostly indirect (portfolio transaction cost)
3. You lose control over realization of capital gains to optimize your taxes.
4. Selecting the most appropriate funds that meet your investment objective is an awesome challenge
You can decide whether investing via Mutual Funds suits you or not based on above factors.
You can see the previous article on the art of investing in mutual fund here.