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Why invest in Mutual Funds vs Other Investment Options

Mutual Fund Industry | May 23
If you were to ask your parents how they invested their money, their answers would tilt in the favour of Fixed Deposits (FDs), Public Provident Fund (PPF) or gold. Their only investment in real estate is likely to be the house they had built around their mid 40s. But, you can’t really blame them for their investment decisions because it was not so common then to invest in mutual funds or shares. When it comes to your generation, there is a plethora of investment options to choose from. Mutual Funds have arisen to become one of the most favoured options of the latest generation. Here are a few reasons why Mutual Funds have unravelled to become a lucrative investment option.

Fixed Deposits

Most Indian investors prefer investing in FDs since they are considered one of the safest investments and can be withdrawn anytime (except tax-saving FDs with lock-in period of 5 years) with nominal penalty charges. However, interest rates are not attractive anymore and they have dipped even further after demonetization. Moreover, interest from FDs is subject to full taxation as per one’s marginal tax bracket which makes FDs extremely tax ineffective. It makes sense to invest in FDs only if you are extremely conservative investor or you have a short-term horizon.

Public Provident Fund 

Another popular investment among the investors with very low risk tolerance, PPF currently fetches the interest rate of 7.9%. Though the maturity amount and interest earned are exempted from tax, the maximum investment limit is only Rs. 1,50,000 per annum. PPF is also very low on liquidity as there is a lock-in period of 15 years and partial withdrawals can be made from the 6th year onwards only. The interest rate on PPF is revised every quarter, which means that the returns can go lower than what you expect.

Gold

Indians are crazy about gold and the whole world knows about it. If they are not flaunting it, then they are hoarding it in their tijoris. Given that gold is a precious metal, it is often valued high in the market, even when the prices are tumbling down. While most people buy gold during weddings, festivals or special occasions, there is also a segment who invests in gold because either they don’t have bank accounts or want to avoid any documentation against purchase or sale. Gold is a highly liquid asset and as good as paper money. Unfortunately, people have a tendency to accumulate gold over generations and don’t sell it even when the prices are high or unless there is a dire need of money. If kept at home, then there is a risk of theft. If kept in a bank locker, there is a fee you need to pay. If you take insurance, you need to declare it. Then, there is a question of purity as well.

Over the past few years, gold as ETF (Exchange Traded Funds) has also emerged as a more convenient and secure option to physical gold. But, again, gold ETF is subject to transaction and fund management charges. 

So, in reality, you are not earning any return on the investment of gold and it is as good as a dead investment. It merely serves as an hedge against inflations and store of value.

Real Estate

It is fascinating how young investors are keen to invest in real estate as soon as they start earning or at least, have decent savings. But, buying a home should not be confused with investing in a property. What’s the difference? Well, you buy a home for personal use and most probably, take a loan against it. So, your investment is actually a liability and not an asset till you are paying EMIs. When you buy a property, you are investing the money which is lying idle with you (assuming and hoping you are not taking a loan!) with the intention of earning a return on it through recurring rental income or sale for capital gain. 

The rental income from the property is taxed at the marginal tax rate of the investor after deducting the payment of municipal taxes and the interest paid to banks on the property loan. It is also a common fact that real estate is not an easily ‘saleable’ investment, making it highly unfavourable on the liquidity scale. Even if you manage to sell it, there are huge transaction and maintenance costs, as well as the tax factor to be considered.

The housing prices may or may not become cheaper, but housing loans are slated to become less expensive, especially after the recent demonetisation drive. Most of the banks are expected to cut their lending rates. So, while buying property will get cheaper, selling it for profit you expect, may become a dream.

Direct Equity

Any investor who is ready to take the plunge in the market is often faced with this question – buy stocks/shares directly or invest in mutual funds? Direct equity is a high risk, high return investment option. It is subject to frequent price fluctuations due to market volatility and can result in complete erosion of capital in an adverse scenario. In order to buy and sell shares at the right market timing and reap profits, you also actively need to monitor the price movement and do thorough research. If you lack discipline or time to do so, and do not have an appetite for high risk then direct equity is not the option for you.

Mutual Funds

Mutual funds are a pool of funds collected from several investors to invest in securities such as stocks, bonds, money market instruments and similar assets. They are specifically designed from the perspective of diversifying your portfolio and catering to risk appetite of every kind. For instance, debt mutual funds give you steady returns, equity mutual funds give you a possibility of high returns and hybrid mutual funds (mix of debt and equity) which give you benefits of steady returns as well as capital appreciation. Since mutual funds invest in a basket of over 20-30 stocks, they do not make or break an investor`s portfolio owing to price movements of individual stocks.

Unlike gold or real estate, you don’t require much amount to invest in mutual fund – you can set up a Systematic Investment Plan (SIP) with a minimum investment of Rs500/- per month. This ensures that you are not burdened by your investments and you can still get superior returns on investment. Also, the other benefit is that if you wish to invest in 10 quality stocks and have a corpus of only Rs. 1000, you will not be able to buy all 10 (because of higher prices). Through a structured vehicle like mutual funds, you can easily buy a portfolio of 30-50 stocks with an investment as low as Rs. 1000!

Mutual funds are also inflation beating instruments, definitely a great advantage over FDs and PPFs. You can also buy or sell mutual funds easily, subject to entry and exit loads of the scheme. 

The core mantra of financial planning is that you keep a long-term horizon to optimize your returns without risking the safety of your investment or affecting the liquidity. Mutual funds meet all these criteria, making them the right fit into your portfolio.

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