Chapter 6: Why Should You Invest in Mutual Funds

Here’s a universal fact: Every individual who saves money, whether retail, high-worth individual (HNI), or ultra-HNI investor, seeks to invest their savings/surplus into various asset classes to grow their wealth.

However, the choice of asset class in which they might invest could depend on multiple factors, such as the capital to be invested, the individual’s risk profile, and, most of all, their knowledge about how every asset class works.

These key factors help individuals choose an asset class and the various instruments available to deploy their savings and generate returns for their future goals.

Some investors who understand equity markets and have the time and skill to invest in them could choose to invest in direct stocks. Some investors who are risk averse may choose debt market instruments to generate regular income from their savings.

Some investors might opt to seek professional help simply because they lack the time or knowledge or expertise to manage their portfolios.

For such investors, mutual funds are a perfect solution.

As we learned from our previous chapters about how mutual funds work, in this chapter, we shall now understand why an investor should invest in mutual funds.

Mutual funds are an excellent investment vehicle for beginners and experienced investors, offering a convenient way to build wealth over time. Here are some compelling reasons why investing in mutual funds makes sense:

Helps to deploy micro-savings through SIPs

Mutual funds allow you to deploy a small portion of your income and invest in various mutual fund schemes through the SIP Systematic Investment Plans feature.

This allows you to invest a fixed amount periodically, say, monthly or quarterly. You need not invest huge amounts all at once. This disciplined approach can help you take advantage of rupee cost averaging and benefit from market fluctuations.

Indeed, SIP is a superpower for small retail investors who can take advantage of starting with smaller amounts, as low as 500 rs a month, and gradually increasing their savings as and when their income increases.

In fact, according to the Association of Mutual Funds India ( AMFI ) data, the Indian mutual fund industry saw a staggering 27.5 million SIP accounts as of March 2023, highlighting the popularity of this investment approach.

Helps investors reap the power of compounding

In the words of Albert Einstein, “ The Power of Compounding is the 8th Wonder of the World.” He who understands it earns it … he who doesn’t … pays it.”

Mutual funds allow you to have a disciplined approach to regular savings. An investor who uses this approach can significantly compound his/her wealth in the long term.

To give you some context, an investor who invests just 5000 per month for 30 years and invests in a mutual fund that makes (assuming) a 12% per annum CAGR return could manage to accumulate a corpus of 1.54,04 866/-

SIP = 5,000/- per month.
SIP Period = 30 Years.
Total Invested Amount = 18,00,000/- (18 lacs)
Total Absolute Gain = 1,36,04,866/- (1.36 crores)
Total Wealth Created = 1.54,04, 866/- (1.54 crores)

It’s astonishing, isn’t it? That’s the power of Compounding. Every investor should consider starting as early as possible, using mutual funds to save early, and letting compounding work wonders in the long term.

Professional expertise to manage your money

As discussed in the beginning, not all investors have the skills, knowledge, or expertise to invest in various asset classes. Most investors invest in asset classes that are randomly recommended by any source, such as friends, family, relatives, or unsolicited recommendations on social media by the so-called Fin Fluncers.

Ultimately, investors invest in asset classes they don’t fully understand and end up making losses or generating returns on their savings, which doesn’t even beat inflation in the long term.

This is where mutual funds can help you. When you invest in a mutual fund, you gain access to a team of seasoned investment professionals who analyse market trends, research companies, and make informed decisions on your behalf.

This expertise can be invaluable, especially for those without the time or resources to conduct in-depth research. Moreover, the mutual fund manager must help you generate better returns and beat the benchmark in the long term.

Gives the benefit of diversification

We all have grown up listening to this advice: Never put all eggs in one basket!

Therefore, diversification is the best way to reduce your risk. The art of “diversification” is a risk management technique that mitigates/reduces the portfolio’s overall risk by allocating investments across different financial instruments in multiple sectors, industries, and asset classes.

A mutual fund manager diversifies risk by choosing hundreds of stocks or bonds in the mutual fund portfolio, which spreads the risk across various sectors, industries, and asset classes.

The Risk is usually higher if mutual fund funds limit their exposure to any single stock in a particular sector in their overall portfolio versus having a well-diversified portfolio with a large number of stocks in its basket.

So, instead of being exposed to one stock, asset class, sector, or industry, the mutual fund portfolio is exposed to multiple stocks and asset classes.

Even mutual fund managers choose to diversify: over the years, some stocks in the portfolio may outperform and give magnificent returns, and some may underperform and give losses, but overall, the goal is that the entire portfolio of mutual funds grows significantly, giving the mutual fund investors consistency in returns in the longer term.

For example, the HDFC Top 100 Fund, one of India’s largest equity mutual funds, invests in over 100 companies in sectors such as IT, finance, consumer goods, and more.

A cost-effective way of maintaining your portfolio

Investing in individual stocks or bonds can be expensive, with brokerage fees and other transaction costs adding up quickly.

Mutual funds, on the other hand, allow you to invest in a diversified portfolio with relatively low costs. As per data from the Association of Mutual Funds in India (AMFI), the average expense ratio for equity mutual funds in India is around 1.5%, generally lower than the costs associated with building and managing a comparable portfolio of individual securities.

Not only this, but where else would you find a Fund Manager who works for you, helps you select stocks after doing extensive research, monitors your portfolio on a regular basis, and does whatever is necessary to help your money grow at such affordable costs?

Mutual funds allow you to choose mutual fund schemes that give you that benefit.

Higher transparency and highly regulated

As we have already learned in our previous chapters, mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI), which enforces strict guidelines and disclosure norms. This regulatory oversight ensures transparency and provides investors with security and accountability.

In fact, SEBI has done a commendable job protecting the rights of investors over the years. They also take up various initiatives and run many education campaigns to spread awareness about how mutual funds work and the risks involved in investing in them. Indeed, this is a blessing for all mutual fund investors.

Something for everything

Mutual funds come in various categories, such as equity funds, debt funds, hybrid funds, and sector-specific funds. We shall discuss these in detail in the coming chapters. This variety allows investors to choose funds that align with their investment goals, risk tolerance, and time horizons.

For instance, investors seeking stable income can opt for debt funds, while those with a higher risk appetite may prefer equity funds. Some may choose a balanced approach and a mix of equity and debt funds. There are endless permutations and combinations that an investor opts for to grow their hard-earned savings through mutual funds.

With the above-discussed advantages, mutual funds can be an excellent starting point for beginners to build an investment portfolio while also providing experienced investors with the benefits of professional management, diversification, and a wide range of investment choices.

By investing in mutual funds, individuals can achieve their long-term financial goals while leveraging the expertise of seasoned professionals and enjoying the benefits of a well-diversified portfolio.

On this note, we end this chapter here. In the next chapter, we shall dive deeper into the subject of Mutual Funds and learn what types of mutual funds are available for investors.