Why invest in mutual funds?

The first step to investing is saving. When we save money, we want to invest it so that it grows in value. The investment options preferred by many people are bank deposits, gold and real estate. Few people invest in stocks and mutual funds. Let us have a look at each of these options.

Bank deposits Bank deposits are simple and everyone knows about them. When we deposit money in the bank, we lend it to the bank and the bank gives us interest. At the time of this writing, we get around 6 percent interest for bank fixed deposits. If we assume 6 percent inflation, real rate of interest is zero percent. If we consider taxes, the real rate of return is negative for many people. Bank deposits are safe and we can get our money back anytime.

Gold Gold is having high liquidity. We can easily sell or pledge it. If we buy gold jewellery, we can lose 10 to 20 percent in various ways (making charges, wastage, GST, etc). The returns from gold are not great. But value of gold does not fall much. It retains its value (purchasing power) and may give returns close to inflation. Safe storage of gold is an issue. We need to use safety lockers in banks. Investing in Sovereign Gold Bonds (SGB), gold ETFs or gold mutual funds is better than buying physical gold like jewellery, coins and bars.

Real estate Real estate can be a good investment option. But we need bulk money to buy property in most locations. We need around 10 lakh Rupees to buy a good plot in villages. In towns and cities, we need 30 lakhs or more. Taking huge loans to buy real estate may not be a great idea as most of the benefits go to the bank (the lender). Residential apartments are not good investments as the rental yields are very low in India. Apartments are good for own use though (If the buyer stays for 10 years or longer). Plots and individual homes can be considered for investment.

Stocks Stocks can give good returns if we pick them right and hold for long time. When the economy grows, the companies also grow and stocks of those companies do well. The issue with investing in stocks is there are thousands of stocks. To pick the right stocks, we need skill and time to study and analyse. Most people don’t have at least one of these.

Mutual funds To start investing in mutual funds we don’t need large amount of money. We can start with 5000 rupees or less. Mutual funds invest in stocks, bonds and gold. I am excited by equity mutual funds (that invest in stocks) as they have the potential to generate 11 to 12 percent return per year (5 to 6 percent higher return than inflation). Debt and gold mutual funds can give returns close to inflation with indexation benefits.

Advantages of mutual funds Here are some good reasons to invest in mutual funds.

High liquidity When we need money, we can redeem our investments in mutual fund and the amount is credited to our bank account in 2 or 3 days.

Professional management Mutual funds are managed by skilled professionals with good experience. Many fund managers have generated returns higher than Sensex and Nifty.

Diversification Mutual funds invest in multiple stocks from different sectors to reduce the risk. Diversified mutual funds cannot invest more than 10% of the assets in one stock.

Transparency Mutual funds publish their unit value (Net Asset Value) on a daily basis (on market open days). Also they publish their holdings (list of stocks held in the fund) once a month.

Tax benefits Equity Linked Savings Schemes (ELSS) or Tax Saving Schemes offer tax benefits (80c) with lock in period of 3 years.

Regulated Mutual funds are regulated by SEBI and the scope for fraud/cheating is almost zero.