Mutual Funds In India: Safe Investment Or Risky Business?

Investing in mutual funds in India can be a safe option, but it is important to understand the risks involved. Mutual funds are a type of market-linked security, which means that they are subject to market risks and volatility. However, they are considered relatively safe compared to investing in individual stocks or bonds due to the diversification they offer. Mutual funds pool money from multiple investors and invest in a variety of assets, reducing the risk associated with investing in a single stock or bond. Additionally, mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI), providing an extra layer of protection for investors.

Market volatility

However, it is important to note that a well-diversified mutual fund portfolio can help to reduce the impact of market volatility. By investing in a variety of assets, sectors, and companies, the risk of losing all your money due to the poor performance of a single asset or market downturn is mitigated.

Additionally, mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI), which helps to ensure transparency and protect investors. SEBI has implemented regulations and guidelines that mutual fund companies must follow, including mandatory disclosures, transparency in functioning, and regular reporting of financial performance. These measures help to reduce the overall risk of investing in mutual funds and provide investors with a sense of security and trust.

Furthermore, mutual funds offer other benefits such as professional management by experienced fund managers, low fees, high liquidity, and tax efficiency. These factors contribute to the overall safety and attractiveness of mutual funds as an investment option in India.

While market volatility is a concern, it can be managed by conducting proper due diligence, understanding your financial goals and risk tolerance, and diversifying your investments across different asset classes and sectors. It is also essential to monitor and review the performance of your mutual fund investments periodically and make adjustments as needed to adapt to changing market conditions.

Fees and expenses

Expense Ratio

The expense ratio is an annual fee charged by the Asset Management Company (AMC) or fund house, expressed as a percentage of the fund's daily net assets. It covers the costs associated with managing the mutual fund, including fund management fees, administrative costs, distribution and marketing expenses, fund manager's fees, registrar fees, and custodian charges. The expense ratio is the major charge associated with mutual funds and can influence your returns. For example, if the expense ratio is 1.5% and you have invested ₹1,80,000, you will be charged ₹2,700 per year. Actively managed funds tend to have higher expense ratios than passively managed funds. The expense ratio can vary, but it is subject to maximum limits specified by the Securities and Exchange Board of India (SEBI).

Transaction Charges

Transaction charges are levied when you buy or sell mutual fund units above a certain value. In India, if you purchase or sell units worth ₹10,000 or more, you will be charged a transaction fee. For new investors, the maximum transaction charge is ₹150 if their transaction value exceeds ₹10,000. For existing customers, the maximum charge is ₹100.

Exit Load

The exit load is a fee charged when you redeem your investments before the expiration of the specified holding period. It is designed to discourage investors from exiting the scheme prematurely and to cover the costs incurred by the AMCs for early redemptions. The exit load is usually around 1% of the total redemption value. For example, if you redeem units worth ₹50,000 before the holding period ends, you will pay an exit load of ₹500. Not all mutual funds charge an exit load, so if you plan to sell units regularly before the holding period, choosing a fund without an exit load is advisable.

Management Charges

Management charges, also known as management fees, are expenses applied to pay the fund manager and cover the costs of managing the investment. These charges are separate from other expenses and are included in the expense ratio.

Account Costs

Some AMCs may charge a fee for maintaining your account if the minimum balance requirement is not met. This fee is taken from the investor's portfolio.

Distribution and Service Fees

The distribution and service fee covers the costs of marketing, printing, and distribution of materials to keep investors updated on the fund's performance and marketing campaigns. It also ensures the fund manager has adequate funds.

Switch Price

Some mutual funds offer the option to switch, allowing investors to transfer all or part of their investments from one scheme to another. This process is called 'switching', and the associated fee is known as the 'switch price'.

Total Expense Ratio (TER)

The TER is the total of all expenses incurred by a mutual fund scheme in an accounting period, expressed as a percentage of the fund's total net assets. It includes management fees, administrative costs, and distribution fees. As per SEBI guidelines, an increase in Assets Under Management (AUM) should lead to a decrease in the TER, and vice versa. The TER is calculated using the following formula: TER = Total expenses incurred in an accounting period X 100 / Total net assets of the fund.

Maximum Expense Ratio Limit

SEBI has set maximum expense ratio limits for AMCs, which vary depending on the total assets under management and the type of fund. The more assets a fund has under management, the lower the expense ratio will be.

Other Fees

There may be other fees associated with investing in mutual funds in India, such as advisory fees, operational costs, legal and audit fees, agent/sales commissions, and ongoing service charges. These fees are typically included in the TER.

Regulatory Guidelines

SEBI has issued guidelines to ensure transparency and protect investors' interests. They have also allowed fund houses to add an extra 0.30% to the expense ratio when selling mutual funds in cities outside the top 30 in India, encouraging investment in smaller cities.

Impact on Returns

The fees and expenses associated with mutual funds can impact your returns. The lower the fees, the higher your returns are likely to be. Therefore, it is crucial to consider the fee structure before investing and make informed investment decisions that align with your financial goals.

Underperformance

To mitigate this risk, it is important to research the historical performance of a mutual fund and understand its investment strategy. Diversifying your investments across different mutual funds can also help reduce the impact of underperformance.

In addition, it is worth noting that mutual funds in India are regulated by the Securities and Exchange Board of India (SEBI). SEBI has implemented regulations and guidelines that mutual fund companies must follow, including mandatory disclosure of information, transparency in functioning, and regular reporting of financial performance. These regulations help ensure that mutual funds operate transparently and efficiently, reducing the risk of fraud and mismanagement.

Furthermore, mutual funds are also subject to periodic audits by independent auditors to ensure compliance with regulations.

While underperformance is a risk, it can be managed through due diligence, diversification, and the regulatory framework in place.

Regulatory oversight

Mutual funds are regulated by the Securities and Exchange Board of India (SEBI), which has established rules and regulations to protect investors. SEBI is the regulatory body that oversees the functioning of mutual funds and ensures that the interests of the investors are protected.

The Association of Mutual Funds in India (AMFI) is another regulatory agency that supervises mutual funds in the country. The presence of these regulatory agencies ensures that mutual fund companies cannot abscond with investors' money. Obtaining a license to operate a mutual fund house involves a rigorous process similar to obtaining a banking license. This makes mutual fund houses as safe as banks in terms of safeguarding investors' money.

SEBI has implemented various regulations and guidelines that mutual fund companies must adhere to. These include mandatory disclosure of information, transparency in operations, and regular reporting of financial performance. These regulations ensure that mutual funds operate with transparency and efficiency, reducing the risk of fraud and mismanagement.

In addition to SEBI's regulations, mutual funds are also subject to periodic audits by independent auditors. These audits provide further assurance that the funds are being managed in accordance with the established regulations.

The regulatory oversight provided by SEBI and AMFI helps to mitigate risks and enhance the safety of investing in mutual funds in India. Investors can have confidence that their investments are being managed by companies that adhere to strict guidelines and are subject to regular scrutiny by regulatory agencies.

However, it is important to remember that regulatory oversight does not eliminate all risks associated with investing in mutual funds. Market volatility, economic conditions, and other factors can still impact the performance of mutual funds. Therefore, investors should conduct thorough research, understand their risk tolerance, and seek advice from financial advisors before making investment decisions.

Liquidity

Liquid mutual funds are a type of debt mutual fund or debt fund that invests in short-term debt securities, fixed-income assets, and money market instruments with maturities of up to 91 days. These funds are managed by professional fund managers, who continuously monitor the portfolio to make investment decisions that align with preserving capital while providing reasonable returns.

One of the primary benefits of investing in liquid funds is their liquidity. Investors can buy and sell liquid mutual funds without incurring extra charges, as there are typically no entry or exit loads. Redemption requests are often processed within one business day, and some funds even offer instant redemptions. This quick redemption process ensures that investors have rapid access to their funds, making liquid funds ideal for those seeking stability and liquidity.

In addition to high liquidity, liquid funds offer other advantages such as low risk, competitive returns, and flexibility in investment amounts. They are considered among the safest mutual funds due to their extremely short lending duration and the high credit quality of the borrowers.

When considering investing in liquid mutual funds, it is important to assess your investment horizon, financial goals, risk tolerance, and the potential returns. While liquid funds are generally safe, it is crucial to review the credit quality of the debt instruments in the fund's portfolio to ensure a safe investment with stable returns.

Frequently asked questions