The Role of Mutual Funds in Wealth Building
Mutual funds need no introduction. Their popularity can be gauged from the fact that in a span of 10 years - from Nov 30, 2013, to Nov 30, 2023 - the assets under management (AUM) of mutual funds have witnessed a five-fold increase. Long-term wealth creation is one of the primary reasons why investors are drawn toward mutual funds.
Prudent investment in them can help you build wealth for various short and long-term goals. The following attributes of mutual funds highlight their role in wealth creation.
Role of Mutual Funds in Wealth Creation
Goal-based Investing
The beauty of mutual funds is that they help you invest as per your goals. Whether accumulating vacation funds or building a retirement corpus, they help you link your investments accordingly. The mutual fund universe is so vast that you can choose different types of funds for the goal you want to achieve (see table below)
| Goal | Type of Mutual Fund |
|---|---|
Tax savings | ELSS |
Vacation / Down payment for car or house | Short-term Debt Funds |
Emergency fund | Liquid Funds |
Children’s higher education / Retirement | Equity Funds |
Goal-based investing ensures that you have money available when needed.
Inflation-beating Returns
An essential part of wealth creation is to beat inflation. Inflation has a decompounding effect, bringing down the value of money. So, it’s essential to stay a step ahead of inflation. This is where mutual funds, especially equity funds, play a crucial role. Equity funds have the potential to deliver inflation-beating returns in the long run.
The table below captures the returns of various asset classes over the last 3, 10, and 20 years period, as per the Wealth Conversations November 2023 report:
| Asset Class | 3-Year Return | 10-Year Return | 20-Year Return |
|---|---|---|---|
Equity (Nifty 50 TRI) | 19.3% | 13.1% | 14.8% |
Gold | 6.1% | 7.4% | 11.9% |
Debt | 4.9% | 7.3% | 7.2% |
Real Estate | 4.8% | 4.5% | 9% |
It clearly indicates that equities have outperformed all asset classes over the long run. Thus, investing in equities through mutual funds and staying committed to your investments can help you counter inflation and bolster your wealth.
Diversification
Risk mitigation through optimum diversification is one of the fundamental investing principles. Diversification ensures your investments are spread across asset classes, and your portfolio’s performance doesn’t depend on the performance of one financial instrument. Mutual funds offer you diversification benefits by spreading your investments across companies in different sectors.
Through optimum diversification, mutual funds ensure you benefit from the rally in one or more sectors and mitigate the impact of poor performance in any single sector. In the long run, optimum diversification helps you ride market volatility and protect the gains.
Start Small and Stay Invested
Mutual funds help you start small and stay invested for the long haul. Through systematic investment plans (SIPs) in mutual funds, you can commence your investment with as little as Rs 500 per month. Also, through SIPs, you can take advantage of rupee cost averaging. It means you buy more units when markets are down and vice versa.
This averages out the cost of buying with time and helps build wealth. Even a modest SIP of Rs 500 monthly in a mutual fund offering 10% annualized returns for 20 years can help you accumulate close to Rs 4 lakhs, subject to fund performance. SIP also inculcates a disciplined savings habit, highly essential for wealth creation.
Top Up Investments
Mutual funds also help you top up your investments in line with an increase in income. This helps in accumulating a bigger corpus. For example, you can top-up your SIPs every year by a fixed percentage as your income rises, which can have a multiplier effect on wealth creation (see table below)
| SIP Amount | Annualized Returns | Investment Duration | Top Up | Final Corpus |
|---|---|---|---|---|
Rs 1000 | 10% | 20 Years | Nil | Rs 7.65 lakhs |
Rs 1000 | 10% | 20 Years | 10% Every Year | Rs 14.61 lakhs |
As you can see, with an annual top-up of 10%, your corpus swells nearly 2 times.
Summing it Up
Wealth creation through mutual funds is a continuous process. By staying committed to your investments and making the necessary adjustments to your portfolio as and when needed goes a long way in your wealth creation journey.
FAQs on The Role of Mutual Funds in Wealth Building
Can I Build Wealth Through Mutual Funds?
Yes, you can build wealth through mutual funds. Prudent investments in mutual funds can help in long-term wealth creation.
Are Mutual Funds Good for Wealth Creation?
Yes, they are. Mutual funds, with their inherent characteristics of diversification and inflation-beating returns, can help create wealth.
