The Role of Mutual Funds in a Diversified Investment Portfolio

Investing is not as easy as you assume it to be. Due to the number of asset classes available in the financial market, it’s a challenging task. These asset classes include bonds, commodities, mutual funds, stocks, gold, etc. This is not the end of the list; there are many more. This makes investing a daunting task, especially while constructing an investment portfolio. And it’s more complex if you are just starting. In that case, you should consider a portfolio of mutual funds. You can compound your returns using this and lower your risk.

In this blog, we will explain the role of mutual funds in an investment portfolio. You will be able to understand their benefits role in a portfolio. So, stay tuned.

Investors are allocated ‘mutual funds units’ for the amount invested at the ‘net asset value.’ In essence, mutual funds offer a straightforward way of investing. Your investments are managed by seasoned professionals, giving you the confidence that your money is in capable hands. Exchange-traded funds (ETF) are also available, but you must open demat account.

Initial Public Offerings (IPO) also provide an opportunity to invest early in companies going public, but they often come with higher risk. Mutual funds, in contrast, provide diversified exposure, which helps mitigate such risks. 

Now, let’s examine the benefits of mutual funds to understand why they must be part of an investment portfolio.

Benefits of Mutual Funds

Diversification

One crucial benefit of mutual funds is diversification. Mutual funds usually have many securities in their schemes, which provides diversification to investors. This is because fund managers invest the pooled funds in different asset classes and market caps. These can be shares, bonds, commodities like gold, and large, mid, or small caps as per the strategy and objectives of the scheme. This helps them manage their risk efficiently. Futures and options can also be used to manage risk.

Broad market exposure

Plenty of mutual fund schemes are designed for investors with different risk appetites. Equity funds are for risk-taking investors, debt funds are for risk-averse investors, and balanced funds are for neutral investors. There are sectoral funds even if someone wants to bet on a specific sector. In short, you can gain exposure to the entire stock market universe using mutual funds.

Professional Management

Managing a portfolio as a do-it-yourself investor is laborious and time-consuming. Let’s agree that not everyone can do this, especially when you are not from this field. In this case, you can invest using mutual funds, asking the fund manager to invest on your behalf. The professionals ensure the fund’s holdings align with the scheme’s objectives.

Low Investment Threshold 

Investing in stocks directly requires a significant amount to buy a sizeable stock. However, mutual fund investments can be started for as low as ₹500. So, you don’t face any investing constraints due to a lack of significant capital. Moreover, you can increase your investment whenever you wish.

Capital growth and income 

You can select the type of mutual funds according to your investment goals and risk tolerance. Mutual funds offer both capital appreciation and income. Bond funds offer regular income, equity funds provide capital appreciation, and balanced funds offer the best of both worlds, i.e., income and capital appreciation.

Flexibility and Liquidity

Unlike fixed assets like real estate, mutual funds offer instant liquidity. For instance, you can buy and sell units of mutual funds in open-ended funds and receive funds within 1-2 business days. You can also withdraw funds from an intraday app within T+1 day in closed-ended mutual funds.

Tax Efficiency

Unlike direct investing, mutual funds offer tax advantages. However, they are restricted to specific schemes like Equity-linked savings schemes (ELSS). Hence, you can invest in ELSS to take tax deductions using Section 80C of the Income Tax Act. This is useful for investors looking to save taxes but who have not exhausted their 80C limits.

Conclusion

All in all, mutual funds are a great product, not only for beginners but also for mature investors. It brings discipline to the investment process. Just assume investing a fixed sum every month, irrespective of where the market will be, for a very long period. 

At the end of your investment journey, you receive an enormous corpus just by regular and disciplined investment. This is entirely different from stocks, which require high capital to buy sizeable chunks of shares to generate good wealth. 

It also requires a lot of experience and time to study. Alternatively, rather than buying whole sector stocks, you can take exposure through sectoral funds by investing as little as Rs 500.

In short, mutual funds have a lot of benefits, and this must be a part of every investor. It compliments even an all-stock portfolio on a stock market app well due to the discipline it brings to investing.          

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