Limitations and Disadvantages of Mutual Funds

 
We have already discussed various advantages of mutual funds.  Well like every financial product, there is other side of mutual funds too. We will list some of the limitations and disadvantages of mutual funds.

Expenses

Mutual funds have management and operational charges. There is team of people and fund manger to manage the mutual fund and they need to be paid. For actively managed funds these charges are more when compared to passive funds. Expense ratio varies for each fund and is clearly mentioned. These expenses reduces your overall returns. 

There is also exit load on mutual funds which is charged by mutual funds if redeemed before a certain period. Exit charges for equity mutual fund are generally 1% if redeemed before 365 days.

No Guaranteed Returns 

Unlike fixed income instruments, mutual funds does not guarantee returns. During a bear market, returns may go negative and minimize your investment amount. In case of bull market, returns may shoot sky high and your investment can double in few years. Returns are fluctuating on daily basis and there is no guarantee of even positive return. Historically, mutual funds give better returns than fixed income instruments but again returns are not guaranteed.

No Investment Control

All the funds are managed by fund managers, they are the decision makers and not you. They decide what to buy and when to buy. They decide what to sell and when to sell. You don't have any control over the decision. You are trusting someone else with your money when you invest in mutual funds.

  

No Intra day trading

Unlike stocks, you can't buy and sell in the middle of trading day. Whenever you purchase mutual fund, units are allocated at the end of the day. Net Asset Value (NAV) is calculated at the end of day and units are allocated according to that NAV. Same rule applies when you redeem units of mutual funds. This makes it difficult to capitalize on sudden market movements.

   

Potential Risk

Mutual funds are risky and returns are dependent on market movements. Downward trend in market can create a hole in your pocket. A crash in market like that of year 2008 may also shatter your dreams. A market collapse may not be easy to handle especially if you are a beginner or a conservative investor. He may never be able to invest in mutual funds again. 

   

Difficult to choose

There are so many mutual funds to choose from. It may not be easy for a new investor to decide which mutual fund to choose from. Before choosing mutual funds you need to evaluate the performance of the mutual fund. Past performance of the mutual fund is no guarantee that mutual fund will also perform better in future. 

Further advertisements can be misleading and may make things difficult for the investor. Ranking and ratings of mutual funds describe only past performance and not the future performance.