Just like any other financial instrument, mutual funds are not without risk. When defined in terms of chances of losing money, the risk in mutual funds is no different than that present in other financial instruments. Still they are relatively safer and a more convenient way on investing.In mutual funds, you can control risk by choosing a fund that suits your risk profile. On the other hand, picking stocks individually that will both meet your objectives and match your profile can be tough.
A mutual fund portfolio is easier to monitor than equity shares. They also come with less systemic risks. They offer quick liquidity. Most private mutual funds can be redeemed in three to four working days. This too cuts the overall risk associated with investing, often not so visible and hence not accounted by many investors. But the market risk or the risk that exists due to economy-wide factors remains. And there is always the possibility that a fund fail to stick to its pre-determined objectives or invests in securities that alter its risk profile. In which case, the blame goes straight to the fund manager and the Asset Management Company (AMC), which manages the mutual fund.
What advantages do mutual funds offer over equity stocks?
Here are a few considerations :
Diversification : Most mutual funds spread the money over a number of shares depending on the fund size. This lowers the risk from an investment loss in a few shares. Even if any one or two shares were to under perform, their impact on the NAV may be only restricted to their proportion of holding. You can’t get much diversification from buying equity shares of a company, unless you buy into a conglomerate.
Systematic Investment Plan : Small sums (starting from Rs 500) of money can be invested monthly or quarterly. A plan for systematic withdrawals is also available from some funds.
Easy entry and exit : Filling a mutual fund application or a redemption form, even online, is all that it takes while entering or exiting a mutual fund. But with equity shares, you need an account with a stockbroker (for buying & selling) and another with a depository participant (which maintains your shares in an electronic form). Some investors may find this cumbersome.
Reinvesting dividends : Funds provide for automatic reinvestment of dividends. In India, this facility is not so far available with equity shares.
Tax benefits : Equity linked savings schemes are covered under the overall limit of Rs. 1 lakh under section 80C.
Professional management : When you are investing in a mutual fund, professionals with experience in fund and portfolio management take care after your money. They are also supposed to monitor the economy and the stock markets to change the portfolio accordingly.
Unless one is ready to dedicate considerable time and effort in stock investing, it is better to invest through the mutual fund route.