5 Limitations Of A Mutual Fund

Sumit Kati

27 Jul 2017

Every coin has two sides to it, but if it’s a coin from the movie Sholay, which Amitabh Bacchan used, then it’s a different story altogether. A lot of websites and articles have been telling us about how Mutual funds are the best available investment tools, but these have limitations, too. 

Lack of portfolio customization
Some brokerages like IIFL ,Motilal Oswal, offer Portfolio Management Schemes (PMS) to large investors. In a PMS, the investor has better control over what securities are bought and sold on his behalf. The investor can get a customized portfolio in case of PMS. On the other hand, a unit-holder in a mutual fund is just one of several thousand investors in a scheme. Once a unit-holder has bought into the scheme, investment management is left to the fund manager (within the broad parameters of the investment objective). Thus, the unit-holder cannot influence what securities or investments the scheme would invest into.

Choice overload
Over 2000 mutual fund schemes offered by 47 mutual funds – along with multiple options within them – makes it a difficult choice for investors. Greater dissemination of scheme information through various media channels and availability of professional advisors in the market helps investors to handle this overload.

No control over costs
All the investor's money is pooled together in a scheme. Costs incurred for managing the scheme are shared by all the Unit-holders in proportion to their holding of Units in the scheme. Therefore, an individual investor has no control over the costs in a scheme. SEBI has, however, imposed certain limits on the expenses that can be charged to any scheme. These limits, vary with the size of assets and the nature of the scheme is published by the mutual fund company.

Size
Some mutual funds are too big to find enough good investments. This is especially true of funds that focus on small companies, given that there are strict rules about how much of a single company a fund may own. If a mutual fund has Rs. 5000 crores to invest and is only able to invest an average of Rs.50 crores in each, then it needs to find at least 100 such companies to invest in; as a result, the fund might be forced to lower its standards when selecting companies to invest in.

Dilution
Dilution is the direct result of diversification. Since investors have their money spread across different assets the high returns earned does not make much of a difference. Thus, when we talk about diversification as one of the key benefits of MF, over-diversification could be one of the major disadvantages/limitation to investing in mutual funds.

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Why to Choose Mutual Funds Instead of Directly Investing Into Equities?

Whether to invest in equities or mutual funds is a question that has plagued every investor. As someone who needs the best value for his/her investment should you invest in equity directly or via mutual funds?

Let’s start by first understanding what these two terms ‘equities’ and ‘mutual funds’ stand for-

Equities- Equities generally represent ownership of a company. If you own any equity in a company, you are a part owner of the said company (depending on how much equity you own).

Mutual Funds – It is an investment scheme which is professionally managed by an asset management company. It pools together the resources of a group of people and invests their money in equities, debentures, bonds and other securities.

Why choose mutual funds over equities?

For people who’ve never invested in either stocks or mutual funds, it is hard to know which is better and where to start. Broadly speaking, if you are a novice investor, mutual funds are not only less risky but also way easier to manage. Here are some ways in which investing in mutual funds is beneficial as opposed to investing in equities -

Diversification

Mutual funds provide more diversification as compared to an individual equity stock. When you invest in equity, you are investing in a single company which has its inherent risk. For example, if you invest Rs.20,000 in buying equities of one company, you could face a total loss if that particular company performs poorly in the market.  

If you invest the same amount in mutual funds, it will be invested in different kinds of stocks and financial instruments, high-risk and low-risk both, so you might not face total loss even if one company does poorly.

Scale of Investment and Lower Costs

For an individual investor buying and selling stocks is a difficult task due to its high price. Thus, any gains made from stock appreciation are nullified if the overall trading costs are considered. Comparatively with mutual funds, as the money is pooled from a large number of investors, the cost per individual is lowered.  

Another advantage of mutual funds is that you don’t need to invest large sums of money. Buying equities for a profitable venture needs huge amounts of money, a minimum of few lakhs. With mutual funds, you can start with Rs.1000 and earn profits on that as well.

Convenience

Keeping an eye on the markets everyday is a time-consuming business, especially if you are investing as a side gig. There are people who spend their lives studying the market and still end up sustaining heavy losses. Though investing in mutual funds does not guarantee high returns, it is stress-free and needs less work as compared to investing in equities.

To sum it up

It is important to remember that mutual funds have their own disadvantages as well. Thus, as with any financial decision, educating yourself and understanding the suitability of all the available options is the ideal way to invest. 


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5 Limitations Of A Mutual Fund

Sumit Kati

27 Jul 2017

Every coin has two sides to it, but if it’s a coin from the movie Sholay, which Amitabh Bacchan used, then it’s a different story altogether. A lot of websites and articles have been telling us about how Mutual funds are the best available investment tools, but these have limitations, too. 

Lack of portfolio customization
Some brokerages like IIFL ,Motilal Oswal, offer Portfolio Management Schemes (PMS) to large investors. In a PMS, the investor has better control over what securities are bought and sold on his behalf. The investor can get a customized portfolio in case of PMS. On the other hand, a unit-holder in a mutual fund is just one of several thousand investors in a scheme. Once a unit-holder has bought into the scheme, investment management is left to the fund manager (within the broad parameters of the investment objective). Thus, the unit-holder cannot influence what securities or investments the scheme would invest into.

Choice overload
Over 2000 mutual fund schemes offered by 47 mutual funds – along with multiple options within them – makes it a difficult choice for investors. Greater dissemination of scheme information through various media channels and availability of professional advisors in the market helps investors to handle this overload.

No control over costs
All the investor's money is pooled together in a scheme. Costs incurred for managing the scheme are shared by all the Unit-holders in proportion to their holding of Units in the scheme. Therefore, an individual investor has no control over the costs in a scheme. SEBI has, however, imposed certain limits on the expenses that can be charged to any scheme. These limits, vary with the size of assets and the nature of the scheme is published by the mutual fund company.

Size
Some mutual funds are too big to find enough good investments. This is especially true of funds that focus on small companies, given that there are strict rules about how much of a single company a fund may own. If a mutual fund has Rs. 5000 crores to invest and is only able to invest an average of Rs.50 crores in each, then it needs to find at least 100 such companies to invest in; as a result, the fund might be forced to lower its standards when selecting companies to invest in.

Dilution
Dilution is the direct result of diversification. Since investors have their money spread across different assets the high returns earned does not make much of a difference. Thus, when we talk about diversification as one of the key benefits of MF, over-diversification could be one of the major disadvantages/limitation to investing in mutual funds.

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