Mutual fund vs other investment avenues

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Bank fixed Deposits Vs Mutual fund

 

Bank fixed deposits are similar to company fixed deposits. The major difference is that banks are more stringently regulated than are companies. They even operate under stricter requirements regarding Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) mandated by RBI.

While the above are causes for comfort, bank deposits too are subject to default risk. However, given the political and economic impact of bank defaults, the government as well as Reserve Bank of India (RBI) try to ensure that banks do not fail.

Further, bank deposits up to Rs 1 lakh are protected by the Deposit Insurance and Credit Guarantee Corporation (DICGC), so long as the bank has paid the required insurance premium of 5 paise per annum for every Rs 100 of deposits. The monetary ceiling of Rs 1 lakh is for all the deposits in all the branches of a bank, held by the depositor in the same capacity and right.

 

Bonds, debentures versus mutual funds

 

As in the case of fixed deposits, credit rating of a bond or debenture is an indication of the inherent default risk in the investment. However, unlike fixed deposits, bonds and debentures are transferable securities.

While an investor may have an early encashment option from the issuer (for instance through a “put” option), liquidity is generally through a listing in the market. Implications of this are:

 

If the security does not get traded in the market, then the liquidity remains on paper. In this respect, an open-end scheme offering continuous sale/repurchase option is superior.

 

The value that the investor would realise in an early exit is subject to market risk. The investor could have a capital gain or a capital loss. This aspect is similar to a mutual fund scheme.

It is possible for an astute investor to earn attractive returns by directly investing in the debt market, and actively managing the positions. Given the market realities in India, however, it is difficult for most investors to actively manage their debt portfolio. Further, at times it is difficult to execute trades in the debt market even when the transaction size is as high as Rs 1 crore. In this respect, investment in a debt scheme would be beneficial.

Debt securities could be backed by a hypothecation or mortgage of identified fixed and / or current assets, e.g., secured bonds or debentures. In such a case, if there is a default, the identified assets become available for meeting redemption requirements. An unsecured bond or debenture is for all practical purposes like a fixed deposit, as far as access to assets is concerned.

The investments of a mutual fund scheme are held by a custodian for the benefit of investors in the scheme. Thus, the securities that relate to a scheme are ring-fenced for the benefit of its investors.

 

Equity versus mutual funds

 

Investment in both equity and mutual funds are subject to market risk.

An investor holding an equity security that is not traded in the market place has a problem in realising value from it. But investment in an open-end mutual fund eliminates this direct risk of not being able to sell the investment in the market. An indirect risk remains, because the scheme has to realise its investments to pay investors. The AMC is, however, in a better position to handle the situation. Further, on account of various SEBI regulations such illiquid securities are likely to be only a part of the scheme’s portfolio.

Another benefit of equity mutual fund schemes is that they give investors the benefit of portfolio diversification through a small investment. For instance, an investor can take an exposure to the index by investing a mere Rs. 5,000 in an index fund.

 

Life insurance versus mutual fund

 

Life insurance is a hedge against risk �" and not really an investment option. So, it would be wrong to compare life insurance against any other financial product.

Various insurance policies are available to meet different needs of investors. Broadly, there are policies that offer only risk cover (term plans) and others which have an element of savings accumulation (endowment). High front-end costs, largely on account of distribution expenses, impact the net return on the savings component of endowment policies.

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