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Sunday, November 21, 2010

Advantages & Drawbacks of Investing through Mutual Fund

The advantages of investing through MFs:

1. They have experienced fund managers, having a good understanding of stock markets.

2. MFs hire researchers, who have an in-depth knowledge of various industries. They also understand various valuation principles well.

3. These experts work full time on researching companies, and are therefore able to better identify good companies.

4. MF researchers often talk directly to the management of the companies, so they get a better insight into the company's strategies.

5. Mutual Funds collect money from many investors, and invest collectively on their behalf. This obviously results in larger transaction volumes, which in turn results in lower percentage transaction costs.

6. MFs manage very large sums of money, as they collect small amounts from many investors. This money is invested on many good companies. This means that if you invest in MFs, you can diversify very well even with small amounts.

If you have Rs. 10,000 to invest, maybe you can buy a couple of shares in 2-3 good companies. This is definitely not diversification! But with the same amount, you can buy units of a diversified equity MF, and you would have a well-diversified portfolio!

7. Since MFs are managed by fund managers whose full time job is to manage money, they can react to any sudden developments in a timely manner.

Please also keep in mind the following disadvantages of investing in mutual funds:

1. Lack of control: Once you invest, you, as an investor, would not have any control of where your money is invested - it would be invested based on the MF scheme's investment philosophy.

(Note: This actually can be the primary reason for investment in an MF - since you don't have the time and expertise, you trust the experts, and let them manage your money!)

Therefore, you should choose the MF scheme carefully, such that its objective is in line with your investment objectives.

If you are convinced that a particular sector is going to perform well in the future, you can invest in a MF scheme that invests specifically in that sector - you can invest in a sector fund. Such schemes come with considerable risk, as they are not diversified, but this is the maximum control you can have while making MF investments.

2. No customization: Since MFs cater to a very large client base, they can not customize their investments.

3. Management fee: MFs charge a yearly management fee. This fee is charged to cover for research and other costs that the MF scheme incurs in the course of its investments. Since this is a yearly fee, it would have an impact on your returns.

But, at the same time, one can also argue that this money is used to perform better in-depth research, and therefore provides a better overall return on your investment!

Now that you know the advantages and drawbacks of MF investments, you should be in a better position to decide whether you want to invest directly in stocks, or want to take the mutual fund route!