Disadvantages of Investing in Mutual Funds

Mutual Funds Disadvantages

Hello, my name is Aryan

And you are very welcome to the Fintekinfo

In this particular post, we are going to discuss the limitations of mutual funds

Specifically about two limitations , See when we talk about mutual funds

Then you must have heard about the ad on TV and radio One line is spoken in it

“Mutual Funds are subjected to market risk. Please read the documents carefully before investing”

Now this line is spoken so loudly And with that, we are habitual of listening to that So we simply ignore that People understand market risk often

That is the stock market, some money is being invested So we have some risk But you can surely make money in the long term But there are some limitations, that we don’t understand upfront I will talk about two weaknesses just like this in this post,

So if you want to understand mutual funds carefully Then it is important to understand these two things Please read this post till the end

Let’s start!

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So let’s talk about the first limitation of mutual funds As I have already said that it is important to carefully read the offer document So in offer documents, one thing is mentioned that on average, how much cash position does a mutual fund will maintain?

And how much money For invest in the market? So why is this cash position is maintained?

Because assume some investors like you and me We may require that money after 2 or 3 years And we want to withdraw the money So for these types of investors and the redemption, that money is kept And it is kept 2 to 5% on average Rest 95% of your money will stay invested in the markets But sometimes if the fund manager wants, then he can increase the amount Because he thinks that there could be some buying opportunities in the stock market This means if he has doubts about falling prices of some stocks

Then he can keep some more money as cash But you will see mostly that it goes 5 to 10% approx No mutual fund keeps more than 10% as cash But there can be some exceptions also Like in a liquid fund, for example, it is necessary to keep 20% cash Because people invest for a short time in that

That’s what liquid funds mean that investment is being made in the short term securities In general equity funds, 5 to 10% of the money is kept in cash Now it has advantages and disadvantages too

The benefit is that if the market rises, and all the money is invested Then mutual funds will get good returns But if the market falls, then the buying opportunity that comes to mutual funds, almost ends

So understand this weakness carefully From where does a mutual fund get money It comes from people like us

When do we people invest?

When the market rises, and many ads goes around When many people get interested in mutual funds, then more money starts to come in When more money comes in, then the market is up anyway If the fund doesn’t want to keep money in cash

Then they will invest all the money in the stock market If they invest in the stock market, and because the market is high Then they will purchase stocks high This means that when its price rises Then by design, they would have to purchase a high amount Second, when do the mutual funds have to withdraw more money from the stock market? When people withdraw more money from the mutual funds

So if the economy is down and many people start to withdraw the money from mutual funds Then obviously mutual funds have to withdraw the money from the stock market So because the market is down and the prices of the stock market are down Then mutual funds have to withdraw the money at that time too So in a way, you can understand that mutual funds have a limitation

That when the stock market starts to get up to speed Then also they have to keep investing money As a retail investor, you and I have the advantage That we can hold the cash And we can hold the cash as long as we want But mutual funds have a mandate that they have to keep the money invested

So this was the first limitation of mutual funds Now we will talk about the second limitation

That is the problem of big money Now the mutual funds have a lot of money to manage and invest That it becomes a problem for them In fact when a mutual fund gets very bigger then it is shut down

But what is this problem?

You may know about Berkshire Hathaway which is a company of Warren Buffet It invests in a big company So Berkshire Hathaway has this problem too And Warren Buffet acknowledges this himself In 1999, in an annual shareholder meeting, which is quite a sort after event Someone asked a question to Warren Buffet That you may have quoted this somewhere

that a small investor can earn more than 50% returns So the answer of Warren Buffet was that , He knows more than half a dozen people who can earn more than 50% returns If they invest their time and intelligence in that If they are managing only 1 million dollar If they are managing 100 million dollars or 1 billion dollars Then it will be very difficult for them too And why will this happen, let’s understand See when a mutual fund has to invest 1000 crores, 2000 crores or 10 thousand crores

And if it finds a small company that can grow See if the base is small, the company is small then it has a wide scope of growth Then mutual funds let’s say if they have to invest 1000 crores in a company And the total valuation of the company is 200 crores,

Then they can not do it And let’s say if the valuation of the company is 200 crore And they will invest 100 crores in that Then they will have a 50% stakes So any mutual fund doesn’t want to be the majority shareholder in any company

And let’s assume that mutual fund invested a small amount of 10 or 15 crores in that company and let’s say the returns are 50% So overall, the asset under management of mutual funds is 10000 crore

Then what has the effect of this on mutual funds? Maybe it will only affect 0.2% So by design mutual funds cannot invest more money in a small company And by design, they cannot earn many returns

A retail investor doesn’t have this limitation Investors like you and I can analyze their stocks themselves , The purpose of starting the master investor series was this only

That we can empower people so that they will understand the market Analyze the stocks

So you can follow our series The purpose behind making this video is not to discourage you From investing in mutual funds But every product has its benefits and limitations

We need to know them Similarly, what are the limitations of mutual funds

We need to know them So that we can decide when to enter and when to exit

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Let’s meet in the next informative post

Till then keep learning and keep earning And be happy as always


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