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Mutual Funds – it can’t get bigger than this!

Disadvantages of Mutual Funds

A mutual fund is managed in the form of a trust, which consists of an asset management company (AMC), custodian, sponsor and trustees. A mutual fund is primarily a mechanism which pools resources by offering units to investors for investment across several classes of assets. The Asset Management Companies which offer various mutual funds charge fees for offering such services. A mutual fund scheme is managed by a fund manager and in some cases, may be aided by a team of professionals as well. Mutual funds are registered with SEBI. There are several types of mutual funds offered in India such as equity, debt, balanced, tax saving and fixed maturity plans among others. Each type of mutual fund has its own advantages and disadvantages.

Mutual Funds - Disadvantages

Akin to most investments, mutual funds offer both advantages and disadvantages, which should be analyzed before you choose to buy one. Some of the disadvantages of mutual funds, in general, as listed below:

  • Fluctuating returns: Mutual funds do not offer fixed guaranteed returns in that you should always be prepared for any eventuality including depreciation in the value of your mutual fund. In other words, mutual funds entail a wide range of price fluctuations. Professional management of a fund by a team of experts does not insulate you from bad performance of your fund.
  • No Control: All types of mutual funds are managed by fund managers. In many cases, the fund manager may be supported by a team of analysts. Consequently, as an investor, you do not have any control over your investment. All major decisions concerning your fund are taken by your fund manager. However, you can examine some important parameters such as disclosure norms, corpus and overall investment strategy followed by an Asset Management Company (AMC).
  • Diversification: Diversification is often cited as one of the main advantages of a mutual fund. However, there is always the risk of over diversification, which may increase the operating cost of a fund, demands greater due diligence and dilutes the relative advantages of diversification.
  • Fund Evaluation: Many investors may find it difficult to extensively research and evaluate the value of different funds. A mutual fund's net asset value (NAV) provides investors the value of a fund's portfolio. However, investors have to study various parameters such as sharpe ratio and standard deviation among others to ascertain how one fund has fared compared to another which can be complicated to some extent.
  • Past performance: Ratings and advertisements issued by companies are only an indicator of the past performance of a fund. It is important to note that robust past performance of a fund is not a guarantee of a similar performance in the future. As an investor, you should analyse the investment philosophy, transparency, ethics, compliance and overall performance of a fund house across different phases in the market over a period of time. Ratings can be taken as a reference point.
  • Costs: The value of a mutual fund may fluctuate depending on the changing market conditions. Furthermore, there are fees and expenses involved towards professional management of a mutual fund which is not the case for buying stocks or securities directly in the market. There is an entry load which has to be borne by an investor when buying a mutual fund. Furthermore, some companies charge an exit cost as well when an investor chooses to exit from a mutual fund.
  • CAGR: The performance of a mutual fund vis-a-vis the compounded annualised growth rate (CAGR) neither provides investors adequate information about the amount of risk facing a mutual fund nor the process of investment involved. It is therefore, only one of the indicators to gauge the performance of a fund but is far from being comprehensive.
  • Fund managers: According to experts, as an investor, you would do well not to be carried away by the so-called ‘star fund managers’. Even a highly skilled manager can make a positive difference in the short-term but cannot dramatically change the performance of a fund in the long-term. Also, there is always the likelihood of a star fund manager joining another company. It is, therefore, more prudent to examine the processes which are followed by a fund house rather than the star appeal of just one individual.

GST rate of 18% applicable for all financial services effective July 1, 2017.

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