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Why Invest in Mutual Funds

There are a number of reasons why mutual funds make great investments. Here are some of them

There are many reasons to invest in mutual funds. To understand these reasons, let us first look at the reason for which we choose investments. There are a number of reasons that drive (or should drive) our choice of investment:

  1. Returns: How much returns can one expect?
  2. Risk: What is the risk of loss?
  3. Liquidity: Is your money locked in? How quickly can you get it back if you suddenly need to?
  4. Taxation: Can this investment save you tax? What will be the taxability of the returns?
  5. Convenience: How much running around and paperwork is needed to make this investment?

Let us examine each of these issues and see where mutual funds stand on them:

Get Started With Small Amounts
If you buy shares yourself, you would need several lakh rupees to build up a balanced portfolio. With mutual funds, you can start with just about ₹5,000, or even less in some funds.

Returns and Risk
In investing, returns and risk are always two sides of the same coin. Investments that offer the potential for high returns generally have higher risk. Shares are a typical example. On the the hand, bank deposits have negligible risk but also offer very low returns. Mutual Funds are a unique investment type that offers whatever combination of risk and return that you want. There are all types of funds, from those that invest only in shares of companies (and thus have potentially high risk and high returns) to those who invest in safe money markets where risks are almost as low as bank deposits but the returns are higher.

Liquidity
Some investments (like PPF, or bank fixed deposits) are locked in for a certain period and cannot be redeemed earlier, at least without paying some penalty. In mutual funds, there are two types--open-ended and closed-end. Open-end ones have the best liquidity and you can get your money back within three days at most. Closed-end ones have a lock-in period. However, all investment needs can be taken care of by open-end funds, which are also superior in other ways.

Taxation
Generally speaking, mutual funds are highly tax-efficient. Whether in equity or fixed-income, you pay less or equal tax than you would if you invested in the alternatives.

Convenience
Mutual fund investments are convenient. There are a variety of ways of getting started. Investment can be done through a fund distributor who will generally come to your home and get all the paperwork done. You can also invest through fund companiesâ€(TM) direct schemes (without a distributor) which will be a little extra effort but yield slightly higher returns. Once the initial paperwork is done, you can deal entirely online.

Questions

  1. In any investment, when the potential for return is high, the likely risk is also high
    • True
    • False
  2. In closed-end funds, you can redeem your money any time you want
    • True
    • False
  3. In open-ended funds, you can redeem your money any time you want
    • True
    • False
  4. Mutual Fund investments can be made through:
    • Yourself, by going to the mutual fund office
    • Through fund distributors
    • Post offices