Why Mutual Fund is A Good Idea To Invest?

Investing in mutual funds has long been a favored approach for both novice and seasoned investors. This form of investment allows individuals to pool their money into a diversified portfolio managed by professional fund managers, who make investment decisions based on extensive research and market analysis. This article examines why mutual funds are a good investment vehicle, discussing various dimensions such as diversification, professional management, and the potential for higher returns. It also elucidates how to identify top equity mutual funds and other related intricacies.

 Diversification

One of the fundamental principles of investing is diversification—the practice of spreading investments across various assets to minimize risk. Mutual funds inherently offer diversification by pooling resources to invest in a spectrum of securities, including stocks, bonds, and other assets. For example, suppose an average investor decides to invest INR 50,000. They might purchase shares of a single company, thereby exposing themselves to company-specific risks. However, if the same amount is invested in a mutual fund, that fund could allocate this across multiple companies in different sectors of the economy. This dilutes the risk associated with any single investment and balances the overall portfolio performance.

 Professional Management

Another compelling reason to invest in mutual funds is professional management. Most individual investors lack the time, expertise, and resources required to scrutinize financial markets, research companies, and monitor investment performance. Mutual funds employ skilled portfolio managers who employ comprehensive research and state-of-the-art tools to manage the fund's assets. This ensures a well-informed, strategic approach to investing which might be difficult for an individual to achieve alone.

 Potential for Higher Returns

Historically, mutual funds, especially equity mutual funds, have shown the potential to generate higher returns compared to traditional savings accounts or fixed deposit schemes. For instance, the average return from top equity mutual funds in India has often outpaced inflation, enabling wealth creation over the long term. For example, an equity mutual fund like HDFC Equity Fund has delivered returns of around 12-15% annually over the past decade, significantly higher than the approximate 6-7% annual returns from fixed deposits.

 Easy Accessibility and Flexibility

Mutual funds offer easy access to a broad array of investments for a relatively small amount of money. One can start investing in mutual funds in India with as little as INR 500 through Systematic Investment Plans (SIPs). Moreover, mutual funds offer flexibility, allowing investors to choose from various schemes depending on their financial goals, risk tolerance, and investment horizon. Whether it’s a short-term goal like a vacation or a long-term objective like retirement, there is likely a mutual fund scheme suited to that purpose.

 Tax Efficiency

Investing in mutual funds also provides tax benefits. Under Section 80C of the Income Tax Act in India, investments up to INR 1.5 lakh in certain mutual funds known as Equity Linked Savings Schemes (ELSS) are eligible for tax deductions. Additionally, gains from mutual funds held for more than one year are taxed at a lower rate than short-term gains, making these funds appealing from a tax efficiency standpoint.

 Calculations: An Example

Consider an investor who starts a SIP of INR 5,000 per month in an equity mutual fund that yields an average annual return of 12%. Over a period of 20 years, the future value of this investment can be calculated using the formula for the future value of a series of investments:

\[ \text{FV} = P \times \left( \frac{(1 + r)^n - 1}{r} \right) \]

Where:

- \( P \) is the monthly contribution (INR 5,000)

- \( r \) is the periodic interest rate (12% per annum divided by 12 months, i.e., 1% or 0.01)

- \( n \) is the total number of contributions (20 years \times 12 months, i.e., 240)

Plugging in these values gives:

\[ \text{FV} = 5000 \times \left( \frac{(1 + 0.01)^{240} - 1}{0.01} \right) \]

\[ \text{FV} = 5000 \times 985.92 \]

\[ \text{FV} = 49,29,600 \]

Thus, the investor’s total investment of INR 12,00,000 (5,000 x 240 months) would grow to approximately INR 49,29,600 at the end of 20 years, illustrating the power of compounding in mutual funds.