The Asset Management Companies (AMCs) in India currently own assets worth Rs. 24.46 trillion. And their Assets Under Management (AUM) are expected to grow at a compounded annual rate of 14% during 2022-2027.
These figures were reported by ResearchAndMarkets.com in their latest study on India Asset Management Market in 2022. They give us an insight into the opportunities to be unlocked in mutual funds. As a beginner investor, the idea of hand-picking individual stocks can be overwhelming.
However, with mutual funds and index funds, we can enter the world of market-linked securities much more easily. Sign up with Koshex to know more about mutual funds and other financial tools.
Let’s read about these two investment instruments in detail and find out why we should choose mutual funds instead of index funds for meeting our financial objective of wealth creation and capital gains.
Different Types of Mutual Funds
A mutual fund is a market-linked investment instrument that pools money from different investors to invest in a basket of different securities including equities, bonds, and other money-market instruments.
The investment fund is managed by a team of experienced professionals led by a fund manager. The manager chooses the fund holdings as per the investment objective and risk appetite of the fund investors.
Mutual funds come in various forms based on risk tolerance and investment objectives. These include equity funds, debt funds, hybrid funds, liquid funds, exchange-traded funds (ETFs), and many more.
What is an Index Fund?
An index fund is also a market-linked investment fund that uses the money pooled from investors to mimic the performance of market indices. These include NIFTY 50, Bank NIFTY, and BSE Sensex.
Unlike actively managed mutual funds, index funds are passively managed. They mirror the investing strategy of the underlying market index.
Why Would I Buy Mutual Funds Instead of Index Funds?
Below we have listed some of the key reasons why we may prefer mutual funds instead of index funds:
1. Active Management of Assets
Mutual funds are actively managed by a fund manager who monitors the performance of the fund. The fund manager allocates assets and decides on behalf of the investor to keep the portfolio profitable.
However, in the case of an index fund, the fund manager does not actively manage the assets. They merely follow the fund composition that the market index directs. So, the fund manager has no scope for active management in index funds.
2. Potential to Outperform the Markets
Since fund managers dictate fund allocation in mutual funds, these funds can beat the market and generate capital gains above the market average return. In contrast, the investment objective of index funds is to generate returns in line with the market index.
Thus, index funds generate returns matching the average market return. If you wish to make more than the average returns, it’s best to opt for mutual funds over index funds.
3. Reducing Risk With Diversification
With mutual funds, we can invest across different companies and sectors, thus reducing portfolio risk. However, with index funds, the diversification scope is limited to the asset allocation structure adopted by the underlying market index.
Index funds generally invest in a particular theme. For instance, an index fund mimicking Bank NIFTY invests only in the top banks and financial institutions of the country. This limits the extent of diversification substantially.
4. Greater Degree of Flexibility
Fund managers curate an investment portfolio under a mutual fund scheme to align with the risk preferences and investment objectives of the fund investors. However, under an index fund, the fund managers follow the asset allocation of a specific market index.
Thus, mutual funds allow for a greater degree of flexibility in choosing shares and debt instruments to invest in.
5. Possibility of Short-Terms Gains
Compared to mutual funds, index funds invest a relatively smaller proportion of the total assets in a particular stock. Hence, index funds are less likely to yield short-term capital gains due to everyday price fluctuations.
However, mutual funds enable short-term gains by allocating a higher percentage of assets to different securities in the portfolio.
6. Wide Array of Options
Lastly, mutual funds offer more options than index funds.
There are various types of mutual funds based on market capitalisation, sectoral allocation, investment goal, liquidity preferences etc.
However, in index funds, the limited number of indices limits the choices. Hence, anyone looking for more fund options must go for mutual funds instead of index funds.
Takeaway
In India, mutual funds are growing in popularity with each passing day, with as many as 134.6 million mutual fund investors in the country. Mutual funds are a perfect choice for those looking for a professionally-managed, rewarding investment.
Furthermore, mutual funds are safe too, being actively regulated and monitored by the Securities and Exchange Board of India (SEBI).
It is often wiser to invest in mutual funds than stocks as the former allows you to invest in a wide range of stocks, that too at a very low investment amount.
You can invest in mutual funds for an amount as low as Rs. 100 via a systematic investment plan (SIP). Moreover, mutual funds offer the benefits of diversification and professional management of funds by industry experts.
Simply put, investing in mutual funds is better than investing in index funds. If you wish to invest in mutual funds, then sign up with Koshex and embark on your journey of fruitful investment today!
FAQs
1. What is the expense ratio of a mutual fund?
The expense ratio of a mutual fund refers to the expenses that investors pay for its administration and management by the Asset Management Company (AMC or fund house). It is represented as a percentage of the Net Asset Value (NAV) of the mutual fund.
2. What are Equity-Linked Savings Schemes?
Equity-Linked Savings Schemes (ELSS) are a type of mutual fund that qualifies for a tax deduction of up to Rs. 1.5 Lakh under Section 80C of the Income Tax Act. However, they come with a lock-in period of 3 years.
3. What makes mutual funds preferable to index funds?
Mutual funds endeavor to outperform the market, while index funds aim for market-average returns.
4. What are hybrid mutual funds?
Hybrid mutual funds are those mutual funds that invest in both equity and debt instruments. They are also called balanced funds owing to their nature of asset allocation.
5. Are there mutual funds that invest in a particular sector or industry?
Yes, there is a type of mutual fund that makes its asset allocation basis an industry selection. These funds invest in the securities of only a particular sector like energy, oil & gas, etc. These mutual funds are known as sectoral funds.
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