Disadvantages of Investing in Mutual Funds

mutual funds

Mutual funds are very popular amongst investors who don’t want to make investment decisions on their own and want to get the benefits of stocks and other marketable securities.

Every coin has two faces, the same applies to mutual funds.

Mutual funds have their own advantages and disadvantages. Every Investor should know the advantages and disadvantages before investing in mutual funds.

In this post, we are going to discuss some disadvantages of investing in mutual funds.

Disadvantages of Mutual Funds

There are some disadvantages of investing in mutual funds which are given below.

Fund Expense

Mutual funds are managed by a financial intermediary called an asset management company (AMC). Managing a mutual fund costs some expenses like brokerages, fund managers fees, compliance, and regulatory fees, including infrastructure costs to manage the funds successfully.

No need to mention, the asset management companies are for-profit firms. They charge their investors some fees to cover all the expenses ranging from 0.1% – 2.5%. This is known as the expenses ratio.

You as an investor should look carefully at the expense ratio before selecting your mutual funds.

If you want to save this expense you can choose to invest in Passively managed funds like index funds. Nowadays many fund houses offer index funds at a very low expense ratio i.e, 0.1%.

Many mutual fund returns are almost the same as market returns which you can get by just investing in index funds, so paying extra fees doesn’t make any sense if your mutual fund schemes are not able to beat the market.

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Over-diversification

Mutual funds are diversified to decrease risk and volatility. It’s a regulatory requirement for mutual funds to diversify their portfolio.

In many cases, mutual funds are not allowed to invest more than 5% of fund capital in any particular stock. It simply means fund managers are going to invest your money in at least 20 stocks or more.

If any mutual funds invest in more than 30 stocks then chances are that their returns will be the same as major indexes like BSE Sensex, which includes the top 30 companies of India according to free-float market capitalization.

Diversification is good to minimize risks but over-diversification also reduces your returns.

You as an individual have a competitive advantage of being a common man. This is the reason many individuals can beat the market and mutual funds very easily by just selecting 10-15 quality companies that have bright futures.

 

Exit Load

It is another charge which will be levied on you whenever you redeem any mutual fund before a given period.

For example, if a mutual fund has an exit load of 0.5% if redeemed before 30 days. It means you will have to pay 0.5% if you will redeem your capital within 30 days of investing.

As a long-term investor, you have nothing to do with exit load but in case after investing in mutual funds you change your mind and you want to switch your capital into another financial product then it can impact your initial capital. So better to look carefully if there is any exit load.

If you have found that there is an exit load then be sure that you are not going to redeem before the given period.

 

Entry Load

As the name suggests, it’s an upfront cost to join any mutual funds.

The good news is that currently, SEBI has removed every type of entry load for all mutual funds.

But if you are investing in international mutual funds, the entry load should not be overlooked.

 

Market Risk

“Investing in mutual funds is subject to market risk. Please read all the documents carefully before investing.”

This type of disclaimer we often heard over and over again in the commercial advertisement of mutual funds along with the tagline “Mutual fund Sahi Hai”.

But nobody explains what types of risk they are talking about. One of the most important risks involved in investing in mutual funds is market risk.

Market Risk is nothing but the dependency on market fluctuations. Because mutual funds are investing money in marketable securities due to which their price goes up and down.

Market Risk is meaningless if you invest for long-term let’s say five-ten years. If the fund manager is good enough then the NAV of your mutual funds will go up over time. The chances of getting positive returns are almost 100% if you are investing for 10 years or more.

Market Risk is not only applied to equity mutual funds but it also affects the debt funds no matter if it is short-term debt funds or long-term debt funds. Debt funds invest in marketable fixed return instruments like bonds, treasury bills, etc. and it depends on the interest rate.

If you invest for more than 6 months, then there will be 100% chances for positive returns. But there is one important point to note that no company is going to default which has issued the debt instruments. And this risk can be avoided successfully if your mutual funds don’t invest more than 2% in a particular debt instrument.

You should also look for asset allocation of mutual funds no matter if it is an equity fund or debt fund.

If mutual funds hold enough position in a company that is on the verge of bankruptcy then avoid investing in that particular fund.

 

Less Return

Last but not least, if you expect a marginally higher return than the whole market then mutual funds are not your cup of tea.

Many mutual funds beat their benchmark. But maybe this wouldn’t be satisfactory for you. All you can do is to hire a financial advisor and let him/her your financial goals. It can be a successful way for achieving your financial goals.

 

No Personal Decision

Once you invest your money into a mutual fund scheme, all the investment decisions will be taken by fund managers.

Suppose you like a company because you use its product/service or whatever reason and you want to invest in this particular company but you can’t invest or suggest your fund manager to invest in that particular company.

If you want to invest in a particular company then you have to invest directly into this company with the help of a stockbroker with separate capital.

Final Thoughts

Mutual funds schemes are best for know-nothing investors, however, you have learned that there are many disadvantages of investing in mutual funds.

Above all, it depends upon your financial goals and your knowledge in the field of investing. If you can manage your finance & investment on your own then go for it otherwise consult with a financial advisor who can guide you to make smart decisions.

There are some other options available along with mutual funds like PMS (portfolio management service), Alternative investment funds, small-cases, etc.

Do some homework before putting your hard-earned money into any financial instruments/schemes.

Happy Investing!

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