Investing in a fund of funds is never a bad idea. A fund of funds is indeed a safe and smart choice to make when it comes to investing your hard-earned money.
But as they say, ‘Read all scheme related documents before investing’, it is extremely important for you to know some of the most basic and important facts like what exactly a fund of funds is, how is your money going to get invested, what should be the term of your investment, what kind of returns can you expect, etc.
So, what exactly is a fund of funds?
Fund of funds is basically a different type of mutual fund that invests in other mutual funds instead of directly investing in stocks, securities, commodities and bonds.
For example, when you invest in a particular mutual fund, that particular mutual fund further invests your money directly in the market. But, when you invest in a fund of funds, the fund of funds invests your money in various mutual funds and then those mutual funds invest in the market.
How does it operate?
There are various types of funds like multi-manager funds, gold funds, international funds and asset allocation funds that operate at varying degrees of risk in order to match the varying requirements and the risk profile of the investor.
If the primary requirement of the investor is to get high returns, the fund of funds will invest in mutual funds delivering high returns which will also have a higher degree of risk and vice versa.
Pros and cons
A fund of funds is undoubtedly a safe choice to make when it comes to investing your hard-earned money. The diversification of your investment across several funds from various sectors along with thorough professional management by expert fund managers ensures minimum risk on your investment.
Moreover, the collective investment strategy of the fund of funds also enables you to invest in some of the top-performing mutual funds even with a limited investment budget. Also, when the fund manager rebalances fund of funds between equity and debt, there will be no capital gain tax for the investor.
Just as every coin has two opposite sides, investing in a fund of funds also has a few disadvantages like high management fees, over-diversification and duplication of the portfolio, lack of transparency and lesser returns compared to direct investment.
One major disadvantage is the taxation process related to the liquidation of a fund of funds. Even though FOFs may invest money in equity-oriented funds, it is taxed as a non-equity fund which is not very tax efficient.
Should you invest?
If you are a budding investor having limited knowledge about the market, minimum investment budget and looking for a long-term and diversified investment option with limited risk, then yes, you should invest in a fund of funds. But if you are an experienced investor and willing to take the extra risk to get higher returns, then you must invest directly in stocks, securities, commodities, mutual funds and bonds.
(The author is Chief Belief Officer & Founder of Fintoo)