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Can Mutual Funds Replace the Traditional Form Of Investments?
With the Indian economy facing a turbulent situation, due to internal and external factors investors are puzzled about where to park their funds.
With the Indian economy facing a turbulent situation, due to internal and external factors investors are puzzled about where to park their funds. Earlier, depositing money in fixed (term) deposits was the most preferred option owing to safety, liquidity and higher interest rates. But as the years roll on, the interest rates on India's most preferred form of investment is also witnessing a plummet. On the other hand, identifying good stocks and sectors which will fetch good returns also seems more difficult given the volatility of the situation.
So investors are now looking to diversify their investment patterns into products which they had not invested earlier. In such a scenario, mutual funds are the best bet as it comes in with various categories which provide a diversified portfolio, asset class choices and consolidation, professional management will help an investor to do the things on themselves instead of relying on others.
Let's take a look at some of the mutual fund categories which can replace the traditional form of investments and yet meet your financial needs.
Short - Term Debt Funds
The short - term debt funds refer to a kind of mutual fund scheme which has an investment term ranging between one to three years (can be extended to four years as well). The investment has stable returns and modest risk factor. These funds are often equated to the fixed deposits which have a similar or equal term at the time of investment owing to similar investment terms.
But the catch here is a short term debt fund is considered to be more tax-efficient as against the traditional fixed deposit. A fixed deposit will earn an investor a maximum interest of 6% - 6.5% as against 8% - 10% annual return fetched from short term debt funds. Apart from this debt funds provides the investor with good liquidity, taxation and returns despite carrying some modest risk.
Currently, the country's largest public sector bank - State Bank of India (SBI) FD interest rate stands at 6% per annum for a tenure of 1 year - 10 years. With these interest rates, it makes the lives of a common man arduous amidst rising inflation rates.
Best managed short term debt funds which come in for a tenure of 2 - 3 years can be chosen instead of fixed deposits as they have generated returns close to 9.5% or more than that.
The debt funds do not attract penalty if they are redeemed before maturity date unless they are redeemed before the pre-determined period (usually 5 days - 6 months). Whereas in case of fixed deposits, despite having a good liquidity factor, they do attract penalty charges if redeemed before the maturity date.
Liquid Funds
Most of the investors park a certain sum of money in a savings account (high liquidity) which will help them to use it for immediate requirements and most of the savings account offered by banks in India fetch an interest rate of 4% per annum.
With meagre interest rates, many investors are unlikely to hold a huge sum of money in these accounts for a long period until it is essential. The fundamental requirement for an investor from this amount is its accessibility and safety.
Liquid funds can be used instead of savings bank account if you do not require money in the next seven days and one just has to bear exit load fee before exiting from the scheme.
Investing in liquid funds provides a high degree of safety and liquidity to investors and it is for this reason, most of the fund managers invest in high credit quality debt instruments.
The allocated proportions in this will be based on the investment objective of the fund. Hence the fund manager will ensure that the average maturity of a portfolio is three months as this reduces the sensitivity of fund returns to interest rate changes.
Investment in liquid funds is an excellent option to park one's idle money. Due to its low-risk factor which at the same time earns higher returns as against the traditional savings bank account. These liquid funds try to imitate the liquidity aspect of a savings bank account.
Hybrid Funds
As the name indicates, hybrid funds are a mix of equity and debt and they form a good alternative for fixed income investors who are enthusiastic to explore equity to earn higher returns. The asset class diversification will reduce the volatility which equity markets go through regularly.
These hybrid funds are suited for beginners as they invest in more than one type of investment securities providing a combination of more than one underlying investment asset class be it stock or money market instruments or bonds.
Bond Funds
A bond fund is also known as debt fund and these funds will be primarily invested in bonds issued by corporates, government, municipals and other debt instruments like mortgage-backed securities.
The primary aim of bond funds is to generate a monthly income to investors. But the only drawback is during economic distress, the risk of default is higher in case of bonds.
Investors should invest in a variety of bonds which will act as a safer bet. Fund managers usually track the quality of these bonds and even if there is a default, its effect will be smaller as the defaulting instruments will form a small portion of your diversified portfolio.
Investors should ensure that they are comfortable with the credit quality of the bonds which they have in their portfolio.
Conclusion
Before switching from the traditional form of investments, investors should examine their suitability. Taking the help of a financial adviser will ease the process. If an investor can effectively communicate his or her desired financial goal and objective they expect from an investment to the financial planning firm, then they will provide the investors with the portfolio plan which best suits them.
Investors should also note that the returns from mutual funds is based on market-related returns and are not stable. So they should give greater care before they pick a particular category of funds which will suit their requirements.
Disclaimer: The article is not a solicitation to buy, sell in securities mentioned in the article. Greynium Information Technologies Pvt Ltd, its subsidiaries, associates and the author do not accept culpability for losses and/or damages arising based on information in this article.
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About the Author
Archana is a Content Writer at GoodReturns. She has been writing articles related to investment planning and personal finance for more than two years.
