Grow Your Money: Top 10 Powerful Reasons to Invest in Mutual Funds

Investing in Mutual funds can be a smart financial move for a variety of reasons. Here’s why you should consider adding them to your investment portfolio:

1. Diversification
2. Professional Management
3. Accessibility and Affordability
4. Liquidity
5. Economies of Scale
6. Range of Choices
7. Automatic Reinvestment
8. Transparency and Regulation
9. Tax Efficiency
10. Flexibility

Additionally, mutual funds organize funds into schemes, offering various options like dividend payout, reinvestment, and growth. Investors select their preferred option, and their investment translates into units. The profitability metric, Net Asset Value (NAV), reflects the true worth of a unit. New Fund Offers (NFOs) mark the launch of a scheme, with the mobilized funds invested according to the committed objective.

Investors enjoy profits or bear losses proportional to their investment, with a cap to prevent losses exceeding the invested amount. The relative size of mutual fund companies is gauged by Assets Under Management (AUM), which reflects the impact of profitability metrics and unit-holder money flow.

However, it’s important to note potential drawbacks, such as the lack of portfolio customization and an abundance of schemes and variants, which can be overwhelming for investors.

But in this post , I will mainly focus in ” Why should we do Investment in Mutual Fund?

lets understand above point in details

10 Top Reasons: Why Invest in Mutual Funds ?

Diversification

Mutual funds invest in a variety of stocks, bonds, or other securities, which helps in spreading the risk. By holding a diversified portfolio, mutual funds can reduce the impact of a single security’s poor performance on the overall fund.

Let’s break down the concept of diversification in mutual funds using a simple example.

Imagine you have a basket and you want to fill it with Eggs. Now, you have two choices:

1. Fill the basket with only one type of Eggs, say chicken eggs.
2. Fill the basket with different kinds of Eggs, like Chicken Eggs, Duck Eggs, Quail Eggs.

Now, let’s say the weather is not favorable for chickens, so the chicken eggs don’t hatch well. However, the duck eggs and quail eggs are unaffected because they thrive in different conditions. In this scenario:

• Basket with Only Chicken Eggs (Not Diversified):
  • All the hen’s eggs will be ruined and will not hatch due to adverse weather. If all of your eggs are hen’s eggs, poor weather conditions can cause poor performance, and you may lose a significant portion of your eggs.
  • This is like investing all your money in just one stock or bond. If that one company or bond performs poorly, your entire investment is at risk and you may lose a significant portion of your eggs.
• Basket with Different Types of Eggs (Diversified):
  • By having a mix of chicken, duck, and quail eggs, you’ve spread the risk. Even if the chicken eggs face challenges, the other types may perform well, balancing out the overall outcome.
  • Mutual funds spread your money across various investments across different types of assets – like stocks, bonds, and other securities. So, even if one stock or bond in the mutual fund doesn’t do well, the impact on your overall investment is minimized because of the diversity within the fund.

You can also understand Diversification by following ways:

• Let’s say the mutual fund invests in 50 different companies, including a technology company, a car manufacturer, and a food company. If the technology company’s stock goes down because people are buying fewer gadgets, the car manufacturer’s stock might still do well because more people are buying cars.
• Alongside stocks, the fund might have government or corporate bonds. These are generally considered safer than stocks. So, even if the stock market is doing poorly, the bonds might still provide steady returns.

The key here is that not all these investments will move in the same direction at the same time. If one stock or sector (like technology or healthcare) isn’t doing well, another might be doing great. This mix reduces the risk that you’ll lose a lot of money all at once.

So, with a mutual fund, you’re not relying on the success of just one company or one type of investment. It’s like having a diverse diet – if one type of food isn’t available, you have other types to keep you healthy. This is what we mean by diversification in mutual funds. It helps to spread the risk and can reduce the impact if one part of the investment doesn’t perform well.

In summary, diversification in mutual funds means spreading your investment across a variety of assets. This helps reduce the risk that comes with relying on the performance of just one type of investment. If one asset or sector doesn’t do well, others in the fund can help balance out the overall performance, potentially leading to more stable and less risky returns.

Professional Management

Mutual funds are managed by professional fund managers who have expertise in selecting investments. This can be beneficial for investors who do not have the time or expertise to manage their own portfolios.

Now, let’s break down the “Professional Management” aspect of mutual funds in simple terms with an example.

Imagine you want to build a house, but you’re not an expert in architecture, construction, or interior design. Instead of trying to do everything yourself and risking mistakes, you’d probably hire a professional builder, an architect, and an interior designer. Each of these professionals has the expertise and experience to make your house strong, functional, and beautiful.

Investing in a mutual fund is similar. Think of a mutual fund like a big financial “house” that’s made up of different “rooms,” each room representing a different investment like stocks, bonds, or other assets. Just like you would hire professionals to build your house, a mutual fund has professional fund managers who are like the architects and builders of your financial “house.”

Here’s how it works:

• Expertise: Fund managers are like the expert architects and builders. They have a lot of experience and knowledge about the stock market, economics, and different types of investments. Just like an architect knows which materials to use or how to design a house, fund managers know which stocks or bonds to pick to build a strong investment portfolio.
• Time-Saving: If you were building a house, doing it all by yourself would take a lot of time and effort. It’s the same with investing. Researching which stocks or bonds to buy, when to buy them, and when to sell them can be time-consuming. Most people have jobs, families, and other responsibilities, so they can’t dedicate hours every day to managing their investments. When you invest in a mutual fund, the fund managers handle all of this for you.
• Diversification: Just like a well-designed house has different rooms for different purposes, a well-managed mutual fund contains a variety of investments. This diversification helps reduce the risk. If one investment performs poorly, it’s less likely to have a big impact on the overall fund, just like if one room of your house needs repairs, it doesn’t mean the whole house is falling apart.

For example, let’s say you invest in a mutual fund that focuses on technology companies. The fund manager uses their expertise to choose a range of tech stocks from different companies. They monitor the performance of these companies, the technology industry, and the overall economy. Based on their analysis, they might decide to buy more shares in a company that’s doing well or sell shares in another that isn’t performing as expected.

In summary, when you invest in a mutual fund with professional management, you’re essentially hiring a team of experts to build and maintain your investment portfolio. This can be especially beneficial if you don’t have the knowledge, experience, or time to do it yourself.

Accessibility and Affordability

Mutual funds allow investors to start investing with a relatively small amount of money. This makes it easier for individual investors to access a diversified portfolio of investments that might otherwise be out of reach.

Accessibility: This means that mutual funds are easy to buy into. You don’t need to be a wealthy or experienced investor. Almost anyone can start investing in mutual funds. They are widely available through banks, brokers, or even online platforms.

Affordability: This refers to the fact that you can start investing in mutual funds with a relatively small amount of money. Unlike buying a property or investing directly in expensive stocks, you don’t need thousands of dollars to start.

Example: Imagine you want to invest in the stock market. One popular company’s stock might cost ₹1000 per share. If you have only ₹1000, you can only buy one share of that company. Your investment is also not diversified because all your money is in one stock. If that company’s stock price falls, your investment suffers.

Now, consider a mutual fund. For the same ₹1000, you can buy shares in a mutual fund that invests in many different companies. Let’s say the mutual fund owns stocks from 50 different companies, including the one you like. Your ₹1000 is now spread across all these companies. This is diversification. Even if one or two companies in the fund don’t perform well, the others might do fine, balancing out the risk.

In summary, mutual funds make it easy and affordable for regular people to start investing, even with a small amount of money, and to have a diversified portfolio that can help manage risk.

Liquidity

Mutual funds offer high liquidity compared to other types of investments. Shares of mutual funds can typically be bought and sold on any business day, providing investors with relatively easy access to their money.

Now, let’s break down the concept of liquidity in mutual funds and illustrate it with a simple example.

Liquidity refers to how quickly and easily an investment can be converted into cash without significantly affecting its market price. High liquidity means you can quickly sell the investment and get your money back.

In the context of mutual funds, liquidity is a major advantage. Here’s why:

• Easy to Buy and Sell: Mutual fund shares can be bought or sold on any business day. This means you can decide to sell your shares on a Monday, and by the end of the day or shortly after, the transaction will usually be processed.
• No Need for a Buyer: Unlike stocks, where you need someone to buy your shares when you want to sell, mutual funds don’t work that way. The fund itself buys back the shares from you.

Now,

Imagine you have invested in a mutual fund, and you suddenly need money for an emergency, like a car repair. With a mutual fund, you can simply request to sell (or redeem) a part of your investment. You submit this request to the mutual fund company, and usually, within a day or two, the cash from the sale will be available to you. This process is straightforward and doesn’t require finding an outside buyer for your shares.

This ease of converting mutual fund investments into cash makes them highly liquid. It’s like having a savings account where you can withdraw money when needed, but unlike a savings account, the value of your mutual fund can increase over time (though it can also decrease, depending on market conditions).

In contrast, some other investments like real estate or certain types of bonds might take weeks or even months to sell, and you might have to lower the price to make a quick sale. That’s an example of low liquidity.

So, in summary, the liquidity of mutual funds is all about the ease and speed with which you can convert your investment into cash, which is a big plus for many investors, especially those who might need quick access to their money.

Economies of Scale

Mutual funds pool the money of many investors, allowing them to invest in a wider range of securities at a lower cost per investor. This can lead to lower transaction fees and operating costs.

What is Economies of Scale?

• Economies of scale occur when the average cost of a service decreases as the scale of operation increases. In simpler terms, as more people participate, the cost per person goes down.

“Economies of Scale” in mutual funds is a concept that can be easier to understand with a simple example. Imagine you and your friends want to buy a large pizza. If you buy a slice each, it might cost more per slice. But if you pool your money together to buy the whole pizza, the cost per slice becomes cheaper. This is because buying in bulk usually costs less than buying individual items.

In mutual funds, a similar thing happens. A mutual fund collects money from a lot of investors, like you and your friends putting money together for the pizza. This pooled money is then used to buy a mix of investments like stocks, bonds, or other assets. Because the fund is buying and managing a large amount of these assets, the costs per investor are reduced.

For example, if you want to buy stocks individually, you might have to pay a brokerage fee each time you buy or sell. But a mutual fund, buying and selling in large volumes, can often reduce these costs. This is because they’re dealing in bulk, much like getting a discount for buying in large quantities.

Similarly, the cost of managing these investments (like paying the fund manager, administrative costs, etc.) is spread out over all the investors in the fund. So, each investor’s share of these costs is smaller than if they were managing their investments alone.

In short, by pooling money together, mutual funds can access opportunities and efficiencies that individual investors might not be able to on their own. This can lead to lower costs per investor, making it a more economical option for many people.

Range of Choices

There are mutual funds available for nearly every type of investment strategy and asset class, from stocks and bonds to more specialized sectors. This allows investors to easily tailor their investment approach to meet their personal financial goals.

Imagine you have some money saved up, and you want to invest it to make more money over time. Now, you’ve heard about mutual funds, and one great reason to consider them is the “Range of Choices.”

Here’s what that means:

Range of Choices Explained: Mutual funds are like baskets that hold different types of investments, such as stocks (like owning a small piece of a company), bonds (like lending money to companies or governments), and other things. These different types of investments are called “asset classes.”

Now, the cool thing about mutual funds is that there are many, many different types of them. It’s not just one-size-fits-all. There are mutual funds that focus on stocks, some on bonds, and even others that specialize in specific areas like technology or healthcare.

Example: Let’s say you’re interested in technology because you believe it’s going to grow a lot in the future. Instead of trying to pick individual tech stocks (which can be tricky), you can choose a mutual fund that specifically invests in technology companies. This way, you’re spreading your money across multiple tech companies, reducing the risk if one of them doesn’t do well.

On the other hand, if you prefer a mix of stocks and bonds for a balanced approach, there are mutual funds designed for that too. You get to pick the mutual fund that matches what you’re comfortable with and aligns with your goals.

So, the “Range of Choices” in mutual funds lets you pick the one that suits your preferences and financial goals. It’s like having a menu of options, and you get to choose the investment dish that fits your taste!

Automatic Reinvestment

Many mutual funds offer the option to automatically reinvest dividends and capital gains, which can help in compounding returns over time.

Imagine you own a small apple orchard. Every year, your trees produce apples, which you can either sell for immediate cash or use to plant more apple trees. If you choose to plant more trees, you won’t get money right now, but you will have more trees producing even more apples in the future. This is similar to what happens with automatic reinvestment in mutual funds.

When you invest in a mutual fund, the fund can earn money in two main ways:

1. Dividends: When the stocks within the mutual fund pay out dividends.
2. Capital Gains: When the mutual fund sells securities for a profit.

Now, when a mutual fund you’ve invested in earns money through dividends or capital gains, you typically have two options:

1. Receive the earnings in cash: This means the fund will pay out the dividends or capital gains to you directly.
2. Automatic Reinvestment: This is where the mutual fund automatically uses those earnings to buy more shares of the fund on your behalf.

Let’s illustrate this with an example:

Imagine you invest in a mutual fund, and you own 100 shares. Let’s say the fund declares a dividend of ₹1 per unit. You would be entitled to ₹100 (100 units x ₹1 per unit).

With automatic reinvestment:

• Instead of receiving this ₹100 in cash, the mutual fund will automatically use this money to buy more unit of the fund for you.
• If the price of each share of the fund is ₹10, your ₹100 dividend will buy you an additional 10 units (since ₹100 ÷ ₹10 per unit = 10 units).
• Now, you own 110 units instead of 100.

The benefit of this approach is that it allows your investment to grow faster over time, a concept known as “compounding.” With more shares, you’ll earn more in dividends and capital gains in the future, which can then also be reinvested to buy even more shares. This cycle can lead to your investment growing at an accelerating rate over the long term.

In simple terms, automatic reinvestment is like rolling a snowball down a hill. As it rolls, it picks up more snow, getting bigger and bigger. Similarly, by reinvesting your earnings, you’re continuously adding to your investment, allowing it to grow bigger over time.

Transparency and Regulation

Mutual funds are regulated by government bodies, ensuring a certain level of transparency and investor protection. Regular reporting requirements mean investors can easily track fund performance.

Transparency and Regulation in Simple Words:

• Regulated by Government Bodies: Think of mutual funds like restaurants that are regularly inspected by health inspectors. Just like inspectors ensure that restaurants follow health and safety standards, mutual funds are monitored by government bodies (like SEBI in the India and SEC in the United States) to ensure they follow certain rules and regulations. This is done to protect you, the investor, from any unfair practices.
• Ensuring Transparency: Transparency means being open and clear about what’s going on. For mutual funds, this is like a restaurant displaying its kitchen to its customers. You can see what ingredients are being used and how your food is being prepared. Similarly, mutual funds are required to be transparent about where they are investing your money and how they are managing it.
• Investor Protection: This regulation and transparency are all about protecting you – the investor. It’s like knowing that the food you’re eating at a restaurant meets certain safety standards. In mutual funds, it ensures that your investment is being handled properly and that the fund is not taking unnecessary risks with your money.
• Regular Reporting Requirements: Mutual funds must regularly share detailed reports about their performance and what they own (their investments). This is like a restaurant providing a detailed nutrition chart for their dishes. As an investor, you get regular updates, which can include information like the value of your investment, what stocks or bonds the fund owns, and how well the fund is doing.

Example:

Imagine you invest in a “XYZ Balanced Mutual Fund.” Here’s how transparency and regulation would work for your investment:

• Regulated: The XYZ Balanced Mutual Fund is overseen by a financial regulatory authority. This means they must follow certain rules designed to protect investors like you.
• Transparent: The fund regularly tells you what they’re investing in. Let’s say they send out a report that shows they have invested in a mix of technology and healthcare stocks, and some government bonds. This report is like a clear picture of what ingredients are going into your investment ‘dish.’
• Regular Updates: Every few months, you receive a statement or report from the fund. It shows how much your investment is worth now, how the fund’s investments have performed, and any changes they’ve made to their investment strategy. This is like getting a regular update on how your favorite dish at the restaurant is being improved or changed.

By having these regulations and transparency, you can feel more secure in your investment, knowing that there are rules in place to protect your money and that you can keep an eye on how your investment is doing.

Tax Efficiency

Certain types of mutual funds, such as index funds and exchange-traded funds (ETFs), can be more tax-efficient than actively managed funds, making them a good choice for taxable investment accounts.

Tax efficiency in mutual funds refers to how much of an investor’s returns are eaten up by taxes. A tax-efficient investment minimizes the taxes you need to pay, allowing more of your money to stay invested and grow over time.

Index Funds and ETFs:

• Index Funds: These are mutual funds that try to match or track the components of a market index, like the S&P 500. They follow a passive investment strategy, meaning they’re not trying to beat the market, but rather mimic its performance.
• ETFs: Exchange-Traded Funds are similar to index funds in that many track indexes, but they trade like stocks on an exchange. This means you can buy and sell them throughout the trading day at market price.

Why They Are More Tax-Efficient:

1. Lower Turnover: Both index funds and ETFs usually have lower turnover compared to actively managed funds. Turnover refers to how frequently investments are bought and sold within the fund. Lower turnover means fewer taxable events (like capital gains) are triggered.
2. Structure of ETFs: ETFs have a unique structure that allows investors to buy and sell shares without triggering capital gains taxes most of the time. This is due to the “in-kind” creation and redemption process of ETF shares, which minimizes the need to sell securities (triggering capital gains) when investors redeem their shares.

Now lets understand this by Comparing actively managed mutual fund and an index fund

Imagine you invest in an actively managed mutual fund and an index fund.

• In the actively managed fund, the fund manager is constantly buying and selling stocks to try and beat the market. Each time a stock is sold for a profit, it potentially creates a capital gain, which is taxable. At the end of the year, you might get a tax bill for these gains, even if you didn’t sell any of your shares in the fund.
• In the index fund, the goal is to match the market, not beat it. So, the fund buys stocks and holds them to mirror the index. This means fewer sales and, therefore, fewer capital gains. As a result, you might have a lower tax bill compared to the actively managed fund.

In summary, if you’re investing in a taxable account (not a retirement account like a 401(k) or IRA), choosing tax-efficient investments like index funds or ETFs can help you keep more of your investment returns by reducing the amount you owe in taxes.

Flexibility

Many mutual funds offer features like systematic investment plans (SIPs) and systematic withdrawal plans (SWPs), which can be tailored to meet individual investment and cash flow needs.

Mutual funds are flexible in a way that they offer different plans and options that suit various individual needs and situations. Two of these flexible options are SIPs and SWPs.

Systematic Investment Plans (SIPs)

• What is a SIP?: A SIP is a way to invest money in a mutual fund. Instead of putting a large amount of money in at once, you invest a small, fixed amount regularly, like monthly or quarterly. It’s like a savings plan where you regularly set aside a certain amount of money.
• Example: Think of a SIP like a piggy bank. Every month, you put $100 into your piggy bank. Over time, this small amount adds up. Similarly, with a SIP, you might invest $100 every month in a mutual fund. Over months and years, these regular investments can grow significantly, especially if the mutual fund performs well.

Systematic Withdrawal Plans (SWPs)

• What is an SWP?: An SWP is the opposite of a SIP. It allows you to withdraw a fixed amount of money from your mutual fund investment at regular intervals. This can provide you with a steady income stream.
• Example: Imagine you have a large water tank (your mutual fund investment) that’s full of water (money). With an SWP, you open a small tap at the bottom of the tank to get a steady flow of water. This is like getting a fixed amount of money, say Rs1000, from your mutual fund every month. This can be helpful if you need a regular income, like during retirement.

Why is this Flexibility Important?

1. Suits Different Financial Goals: SIPs are great for long-term savings goals like buying a house or saving for retirement. SWPs are helpful for those who need regular income, like retirees.
2. Helps in Market Timing: With SIPs, you don’t need to worry about the right time to invest. Since you invest regularly, you buy more units when prices are low and fewer when prices are high. This averages out the cost of your investment over time.
3. Easy on the Budget: SIPs allow you to invest in small amounts, which doesn’t strain your budget. You don’t need a lot of money to start investing.
4. Regular Income with SWPs: For those who need regular money to meet their expenses, SWPs provide a predictable and steady income.
5. Adjustable: You can usually change the amount or frequency of your SIP or SWP, making it very adaptable to your changing financial situation.

In conclusion, the flexibility offered by mutual funds through SIPs and SWPs makes them a suitable investment option for a wide range of investors, from those who are just starting to save to those who need a regular income stream.

While mutual funds offer many advantages, it’s important to remember that all investments carry some level of risk, including the potential loss of principal. Investors should consider their own financial situation, risk tolerance, and investment objectives before investing in mutual funds and Must take financial advice from financial adviser.