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Why is mutual fund important in a person’s portfolio

  • The mutual fund industry has enjoyed substantial growth in terms of the assets under management as well as the investors’ accounts. Of many reasons that contributed to the growth of mutual fund industry, the fundamental one is the increasing complexity of modern investment..
  • Expert Money Management

  • Individual investors may not have the time or professional expertise to decide which fund to invest in or how to. A mutual fund company employs professional managers to manage the money pooled in their funds. They decide which company share, sectors/stocks or debt papers to invest the money or whether to hold on to the capital. Their decisions will be in the investors’ interest..
  • Flexibility to switch funds

  • A serious investor (or fund manager) knows when to switch from the current fund to another to keep up with or stay ahead of the market. There are many mutual fund schemes that allow this. The asset manager has to keep a sharp eye on the market to know this. This ensures better returns while not getting burned by market volatility..
  • Lock-in Period

  • Lock-in periods differ for every mutual fund. Starting from one month to none at all. For instance, ELSS is a tax-saving mutual fund scheme with the shortest lock-in period of 3 years. The longer the holding period (beyond the mandatory lock-in), the better returns you earn and vice versa. Open-ended mutual funds generally do not have lock-in periods and you can close/withdraw them anytime..
  • Investments based on goals & focus sector

  • Every investor has a financial goal. It could be a short-term goal such as an international holiday or a long-term goal like fixed income post retirement. Also, different schemes focus on different assets and outcomes with varying risk factors. This allows investors to drive money to various asset classes as per their risk appetites and goals..
  • Diversification

  • Mutual funds invest across assets, company sizes and shares to spread the risks. When one underperforms, the other gains can even out the loss. This is diversification. However, it is recommended to not invest in too many (more than 5) as it may get difficult to monitor. Also, stocks of these companies always tend to be homogeneous, which beats the purpose..
  • SIP option

  • If you do not wish to make a one-time investment, you can invest in smaller and manageable installments called SIP. Systematic Investment Plans foster financial discipline in investors. As it averages the rupee cost, SIP is an ideal alternative to mid- income and low-income investors. You can start with as low as Rs. 500 to make your initial installment with ClearTax..
  • Economies of Scale:

  • Mutual funds also provide economies of scale. Buying one spares the investor of the numerous commission charges needed to create a diversified portfolio. Buying only one security at a time leads to large transaction fees, which will eat up a good chunk of the investment. Also, the $100 to $200 an individual investor might be able to afford is usually not enough to buy a round lot of a stock, but it will buy many mutual fund shares. The smaller denominations of mutual funds allow investors to take advantage of dollar cost averaging.
  • Individual-Oriented:

  • All these factors make mutual funds an attractive options for younger, novice and other individual investors who don't want to actively manage their money: They offer high liquidity; they are relatively easy to understand; good diversification even if you do not have a lot of money to spread around; and the potential for good growth.
  • Professional management

  • As a mutual fund investor, you get the benefit of having a professional manager reviewing the portfolio on an ongoing basis. Professional portfolio managers and analysts have the expertise and technology resources needed to research companies and analyze market information before making investment decisions. Fund managers identify which securities to buy and sell through individual security evaluation, sector allocation, and analysis of technical factors. For those who have neither the time nor the expertise to oversee their investments, this can potentially be invaluable..
  • Liquidity and convenience

  • All mutual funds allow you to buy or sell your fund shares once a day at the close of the market at the fund’s NAV. You can also automatically reinvest income from dividends and capital gain distributions or make additional investments at any time. For most stock funds, the required minimum initial investment may be substantially less than what you would have to invest to build a diversified portfolio of individual stocks..
  • Tax considerations

  • The securities held within the portfolio often pay dividends or interest. Securities can also be sold by the fund manager after rising in value. These types of events can help generate income for the fund, which by law must be paid out to investors in the form of periodic distributions. For the most part, investors who own shares in the mutual fund at the time these distributions are made are responsible for the taxes on that money. However, the income from funds that invest in municipal bonds may be exempt from federal, and in some cases, state taxes..
  • Investors who own mutual funds that are not held within an IRA or another tax-advantaged account may be subject to three different types of taxes:.

    • Dividend income, which is generally taxed at your ordinary income tax rate
    • Capital gains from the sale of securities, which can be taxed at your ordinary income tax rate or the more favorable long-term capital gains rate, depending on how long the securities were held by the fund.
    • Capital gains when you sell or exchange shares of the fund at a profit; those capital gains could also be taxed at your ordinary income tax rate or the more favorable long-term capital gains rate, depending on how long you held those shares.