When you first begin your journey of investments, you tend to opt for risk-free financial instruments like fixed deposit and recurring deposit. While these instruments offer guaranteed returns, they are time-consuming and given the rate of inflation, are unlikely to help achieve your financial goals. Hence, a lot of financial recommend amateur investors to turn to other financial instruments like mutual funds. As novice investors, it is natural to be concerned about the risks involved while investing your hard-earned money. One of the first questions you would want to ask your financial advisor before investing in mutual funds is whether or not it is safe to invest in mutual funds. Let's find out!
When you invest in a mutual fund, there are two major concerns - will you be able to accumulate enough capital gains without losses and whether the asset management company handling the pooled funds is trustworthy. For the latter part, investors need not worry as all domestic mutual funds are regulated and monitored by two regulatory agencies, namely, the Securities Exchange Bureau of India (SEBI) and the Association of Mutual Funds in India. SEBI and AMFI play an essential role in regulating all the players operating in Indian capital markets, and their agenda is to protect the interest of investors. Unlike non-regulated chit funds, there is no opportunity for the fund house or asset management company to flee with the pooled funds.
Now the second major concern while investing in a mutual fund - the risk.
Yes, there is a certain element of risk involved while investing in mutual funds as their outcome is linked to market movements. But there are a lot of factors that need to be considered and these factors will help balance the risk involved while investing in mutual funds.
While investing in a traditional financial instrument with zero risk that ensures guaranteed returns, the returns are going to be limited. Depending on your age and specified tenure at the time of investment, you will get returns as high as 7%. But mutual funds are meant for larger capital gains. A well-managed mutual fund has the potential to earn capital gains as high as 12%. That is nearly double of what is offered by traditional financial instruments like fixed or recurring deposits. The agenda behind a mutual fund is to exploit the securities markets and make as much as possible. In essence, this allows investors to plan for specific financial goals, including education for their children, planning family vacations, buying a new home, retirement planning etc.
What makes mutual fund investments using a systematic investment plan (most popular among investors) a lot safer is that it factors in the uncertainty of life. What if there is a family medical crisis and the investor cannot afford to invest the SIP amount for that month? In such a situation, the investor can pause the SIP and start reinvesting when they can. Is this possible in a recurring deposit? No. If you don't have enough funds to invest in a recurring deposit during a particular month, your recurring deposit stands cancelled.
Let's say the investor has been investing in a mutual fund for ten years and has been receiving significant capital gains. But, now the investor wants to send their children abroad for higher education. With an education loan, the investor will be paying a high rate of interest (12% in some cases) to the bank. That's higher than the interest on a home loan. But what if the investor didn't have to opt for a loan? All they would have to do is withdraw from the mutual fund they have been investing in and use the capital gains (potentially 12% or higher) to fund the education of their children.
Mutual funds offer better tax-efficiency in comparison to traditional financial investment instruments. The short term, as well as long term gains from mutual funds, are taxed in such a way that you don't end up paying a significant chunk of your returns as tax. Additionally, some mutual funds, like the equity-linked savings scheme or ELSS, are specifically designed to cater to tax savings.
If you are still unconvinced whether or not mutual funds are safe, you can always invest in mutual funds that cater to your risk appetite. If you are keen on higher returns, you can invest in mutual funds that invest in equity securities. Additionally, if you have a low-risk appetite and still wish to invest in mutual funds, you can always invest in debt funds that offer low risk and low returns. For a healthy mix of both, you can always invest in hybrid mutual funds.