People make mistakes by investing money that they may need in the short term in equity mutual funds or putting money that they may need to meet long-term goals in bank fixed deposits (FDs).
People generally avoid mutual fund (MF) investments due to the risk of capital fluctuation due to ups and downs in the stock markets in the short term. However, one should keep in mind that equity investments are long-term investments, and one should not be concerned about short-term fluctuations. Instead, one should invest only the amount of money that they can spare over a long period of time. They should choose more stable options such as debt funds, fixed deposits (FDs), or savings bank accounts to park the liquid money that is required during times of contingency.
A mutual fund provides diversification by investing in a variety of stocks. Owning shares in a mutual fund is preferable to owning a single stock because an individual stock carries more risk than a mutual fund. This is referred to as unsystematic risk.
Unsystematic risk is a risk that can be mitigated by diversification. For example, owning just one stock exposes you to company risk that may not apply to other companies in the same market sector. What if the company’s CEO and the executive team suddenly leave? What if a natural disaster strikes a manufacturing facility, slowing production? What if earnings are down due to a product defect or a lawsuit? These are just a few examples of things that could happen to one company but are unlikely to happen to all companies at the same time.
There is also a systematic risk, which is a risk that cannot be mitigated by diversification. This is analogous to market risk or volatility risk. You should be aware that investing in the market entails some risk. If the market as a whole declined in value, this is not something that can be easily hedged against.
Mutual funds have grown in popularity among a wide range of investors. This is primarily because they provide automatic diversification, as well as the benefits of professional management, liquidity, and customizability.
Diversification is the name of the game in investing because it allows the investor to spread his total risk across a variety of investments. To achieve optimal diversification in a self-managed portfolio, the investor or his financial advisor must research and track a wide range of investments in various sectors and markets.
One of the primary advantages of investing in the stock market is the ability to buy and sell shares at any time. Similarly, shares in open-end mutual funds can be purchased or sold at the shareholder’s discretion. While mutual fund shares are not traded on the market in the same way that stocks or bonds are, shareholders can redeem shares directly with the fund or through a registered broker. As a result, most mutual funds are as liquid as traditional stock investments, with the added benefits of diversification and professional management.
Management of Professionals
Another reason mutual funds are popular is that they are managed by professionals who have the necessary experience to properly judge the profitability of various investments. Fund managers, unlike individual investors, are less likely to fall victim to the pitfalls of emotional investing motivated by greed and fear. Fund managers are also uniquely motivated to ensure that their funds are as profitable as possible, regardless of their personal feelings about the companies or governments that issue assets in the fund’s portfolio.