How are mutual funds different from traditional investment options?

Posted On: 25 July 2023

In the early days of investing, individuals relied on traditional investment options like fixed deposits, public provident funds, and life insurance policies. These options provided stability and security, but they often limited the potential for higher returns. But with the advent of mutual funds, a dynamic market-linked financial instrument, the Indian investment landscape has been revolutionized.
Especially for the less experienced investors, mutual funds have opened the doors to diversification and compounding. In fact, many youngsters today are opting for mutual funds over traditional investment methods. In this article, we will compare mutual fund investments and traditional investment options (PPFs, bank deposits and life insurance policies) to help understand the benefits and advantages of the former.
Let’s take a look.

Table of contents

What are mutual fund investments?
Difference between mutual fund investments and traditional investments
FAQs

What are mutual fund investments?

A mutual fund is an investment vehicle, managed by a professional under a fund house (Asset Management Company), which pools money from multiple investors and invests it in stocks, bonds, and other securities. Mutual funds in India were introduced in 1964 with the establishment of the United Trust of India (UTI). Since then, this investment vehicle has witnessed a rapid upward trajectory.
Mutual funds allow small or individual investors to access professionally managed equities, bonds, and securities, making them participate proportionally in the gains and losses of the fund. These funds follow the old saying of ‘Don’t put all your eggs in one basket’ and invest in a wide range of companies and sectors. This offers a diverse portfolio to an investor. Besides being affordable, mutual funds can easily be redeemed at any time, for the current net asset value NAV,subject to exit load.
However, one should remember that investments in mutual funds are affected by several factors like investment horizon, risk appetite, performance of funds, fund manager's expertise and taxation. Thus, a well-informed decision while choosing mutual funds can do wonders for an investor.

Difference between mutual fund investments and traditional investments

Globally, India is one of the few countries which have the highest savings rate. However, traditionally, Indians have preferred investing in assets offering guaranteed returns, irrespective of how low the returns are. A major part of the savings is therefore invested in tangible assets like fixed deposits and real estate. However, with the expansion of mutual funds schemes in the Indian market, the thought process of many Indians are evolving. Here’s a brief comparison of mutual funds vs traditional investments.

Mutual fund vs. PPF

Considered one of the most secure forms of investment, Public Provident Fund (PPF) is a savings scheme that is offered by the government. PPF delivers a fixed rate of interest plus tax benefits under Section 80C. You can open a PPF account in various nationalized banks and post offices with a tenure of 15 years.
Although PPF is termed as a safe investment vehicle, its returns are usually comparatively much lesser than equity based mutual funds on a long term. Mutual funds are capable of generating better return potential as they invest in diverse assets. And, since mutual funds do not have a lock-in period of 15 years, they can be redeemed anytime as per the convenience of the investor, thereby offering high liquidity. However, unlike PPF which offers fixed return, return from mutual funds are subject to market risks and there is no assurance or guarantee of return.

Mutual fund vs. bank deposits

Bank deposits, such as fixed deposits (FDs), have long been a popular choice for risk-averse investors seeking stable returns. FDs offer a fixed interest rate for a specified period. The current rate of interest offered by different banks on fixed deposits for one-year tenure ranges approximately from 6% to 8%.
However, unlike fixed deposits, mutual funds provide the opportunity for long term capital appreciation through market movements. While FDs assure capital protection, they may not keep pace with inflation, leading to reduced purchasing power over time. Mutual funds, with their potential for better long term returns, can help investors combat inflation and generate wealth in the long run. However, unlike bank deposits that offer fixed return, return from mutual funds are subject to market risks and there is no assurance or guarantee of return.

Mutual funds vs. life insurance investments

Life insurance policies, such as endowment plans or money-back policies, combine insurance coverage with investment components. While life insurance provides financial protection for policyholders and their families, the investment portion typically yields moderate returns. In contrast, mutual funds, with their focus on capital growth, offer better return potential. However, it's important to note that life insurance plays a crucial role in risk management and should not be solely replaced by mutual funds.
To conclude, mutual funds have emerged as a powerful tool for individuals to grow their wealth. Mutual funds have the potential to offer several advantages over traditional options like PPFs, bank deposits, and life insurance policies. Mutual funds provide diversification, professional management, and the potential for higher returns over long term. However, it's essential to assess one's risk tolerance, investment objectives, and time horizon before investment in mutual funds.
Seeking guidance from a distributor or a qualified financial advisor can help investors make informed decisions and navigate the vast array of mutual funds available.

FAQs

What is the difference between actively managed and passively managed mutual funds?

Actively managed mutual funds involve professional fund managers making investment decisions, aiming to outperform the market. Passively managed funds track specific market indexes, aiming to replicate their performance without active decision-making.

What factors should I consider when choosing a mutual fund for investment?

Consider factors such as investment goals, risk tolerance, fund manager's track record, investment strategy, and asset allocation when choosing a mutual fund for investment.

Are mutual funds suitable for conservative investors compared to traditional investment options?

Mutual funds can be suitable for conservative investors, but it depends on their risk tolerance and investment objectives. Traditional options offer stability, while mutual funds offer growth potential. Conservative investors can opt for low-risk mutual funds to balance return potential and market volatility.

Can mutual funds provide higher potential returns than traditional investments in the long run?

Yes, mutual funds can offer relatively better return potential compared to traditional investments in the long run. By investing in a diversified portfolio and benefiting from professional management, mutual funds can tap into market opportunities. However, returns are subject to market fluctuations unlike traditional investments that provide fixed returns.

How can I choose between mutual funds and traditional investments based on my investment goals and risk tolerance?

Choosing mutual funds vs other investment options should be based on your investment goals and risk tolerance. Consider factors such as growth potential, stability, liquidity needs, and time horizon. Aligning your preferences with these factors will help determine the most suitable investment approach.

Mutual fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.