What makes investing in mutual funds attractive?

Mutual funds evolved way back in 1963, but have gained attention in recent times post demonetization and the digital India campaign. Even SEBI (Securities and Exchange Board of India) and AMFI (Association of Mutual Funds in India) have become the forerunners in bringing awareness about mutual funds among investors. However, people still wonder why they would invest in mutual funds rather than in other instruments such as insurance, PPF, bank FDs (Fixed Deposits), post office schemes, etc.

With respect to mutual funds, people make investment decisions based on two major factors – returns (specifically which are guaranteed) and risk. Owing to those considerations, people tend to move to bank FDs and government securities which give them guaranteed returns with less or virtually no risk. Nonetheless, one should not base their investment decisions solely on these two factors. Let us go on to discuss what makes mutual funds a more attractive investment product.

Returns

Return is a factor that people tend to give the highest weightage to. One of the most common questions asked by people is the rates of return that mutual funds provide in comparison to bank FDs.

It is crucial to understand that returns depend on various factors such as asset class, investment horizon, investment objective, etc. Looking at the historical performance of mutual funds helps to better predict if they will perform well and are capable of providing better inflation-adjusted returns.

Discipline

Investors should be disciplined enough so as to actually benefit from their investments. Systematic Investment Plan (SIP) is one of the facilities in mutual fund which allows investors to invest small amounts regularly over a period of time. Usually, it is preferred to invest on a monthly basis but one can also do so daily or annually via SIP. This feature enables to stay invested in a disciplined manner by regularly participating in market.

Diversification

It has been correctly stated to not put all eggs in one basket while investing. This suggests spreading out your investment across different asset classes to reduce your risk. Mutual funds are structured in a way such that you automatically get the diversification benefit since the fund manager invests in various stocks of different sectors. With hybrid mutual funds, the fund manager invests in both equity as well as debt to further diversify across asset classes. Yet, this does not imply that you place all your money in a single mutual fund; however, it has been observed that beyond a certain limit, investing in more and more number of mutual fund schemes does not provide any diversification benefit.