November 29 , 2012
As a structure, mutual funds have inherent advantages:
- Expert research team and fund managers - Unless you devote full time to research, you cannot expect to do justice to your portfolio. In mutual funds, you just leave the research to the specialists and relax while they do their job and deliver returns for you
- Diversification - A single stock or a single bond inherently has risks. Think of the Satyam or the Enron debacle. But as a market, the risks are far lower. This simple concept, wherein you use the fact that not all stocks go bad at the same time, though individual stocks sometimes could, is called diversification. Mutual funds use this to your advantage, through holding several stocks or bonds at any given time
- Risk control - Experts in the regulatory bodies, and in the fund houses themselves, have laid down strict rules that funds must follow. This is a scientific way to keep risk low and manageable. You would struggle to do this yourself.
There are some special advantages of mutual funds in the Indian context:
- Customer friendly regulatory environment - Mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI). Over the years, SEBI has introduced several features to make mutual funds customer friendly - such as safety, low transaction costs, transparency on fund portfolio and strict disclosure norms for the funds. Indeed, in several ways, investing in mutual funds in India is cheaper and easier than in the West.
- Tax treatment - Mutual funds enjoy a favorable tax treatment in India, far better than even the US and several Western markets. In India, they are treated as a pure pass-through, i.e. there is no separate taxation of funds. In case of equity and gold, the only tax that happens is at the product level. In case of debt, it is even better. While interest from debt if you invest in a fixed deposit is taxed as income, mutual fund debt is taxed as capital gains, a far more lenient system.
- Low cost - As a result of the above points, the annual cost of holding mutual funds in India is very low (hardly 2% in case of equity and less than 1% in case of debt). This is a very small price to pay compared to the returns you can generate, and the other benefits mentioned above.
There are very few cons of a mutual fund. In fact, we struggle to think of any serious contender! But yes, for certain expert and involved investors who are regularly updated on the market, mutual funds may be unnecessary. They may prefer to deal in the equity or debt markets directly.