Does fund of fund make sense?
It's never a terrible idea to invest in a fund of funds. When it comes to investing your hard-earned money, a fund of funds is a safe and wise option.
However, as the saying goes, "read all scheme related documents before investing." It is critical that you understand some of the most basic and important facts, such as what a fund of funds is, how your money will be invested, what the term of your investment should be, what kind of returns you can expect, and so on.
What is Fund of Funds?
A mutual fund scheme that invests in other mutual fund schemes is known as a Fund of Fund. Instead of investing directly in equities or bonds, the fund manager manages a portfolio of other mutual funds. A FoF may invest in a scheme run by the same fund house or in a scheme run by a different fund house. The portfolio is tailored to investors with a variety of risk profiles and financial objectives. As a result of investing in a variety of fund types, investors are able to profit from diversification.
The FoF can be both domestic and international. The fund manager of a foreign FoF invests in units of offshore mutual fund schemes. He or she double-checks that the target fund's investment philosophy and risk profile match the fund's mission. The primary goal is to accumulate wealth over time.
How does it operate?
Multi-manager funds, gold funds, foreign funds, and asset allocation funds are just a few examples of different types of funds that operate at varied risk levels to meet the needs and risk profiles of investors.
If the investor's primary goal is to earn large returns, the fund of funds will invest in mutual funds that give high returns but also have a higher risk, and vice versa.
Asset Allocation Funds: Asset allocation funds are mutual funds that invest across a wide range of asset classes. These assets can be either equities or debt-oriented, or they can be other asset classes like gold, other metals, or commodities.
Gold Funds: These funds invest in gold in a variety of ways, including actual gold. They also invest in gold mining company stocks.
Foreign or International Fund of Funds: International funds are mutual funds that invest in bonds and stock of multinational corporations.
Multi-manager Fund of Funds: A multi-manager fund is a portfolio made up of multiple professionally managed funds.
Who should invest in Fund of Funds?
Small investors that do not want to take on more risk might consider the Fund of Funds. Diversification of funds can help to mitigate risk. This is also a good investment option for someone who just has a modest quantity of money to invest each month. Furthermore, individuals with a five-year or longer investment horizon might consider investing in this fund.
Things to consider as an investor
The concept of a Fund of Funds is based on the idea of getting the most out of a single yet diversified investment plan. Before making any investment decision, you must assess the benefits and drawbacks of this programme as an informed investor. Choose a seasoned fund manager and be aware of your risk appetite, transactional deadlines, and tax consequences, among other things. Some of the advantages and disadvantages of investing in Fund of Funds that one should be aware of are listed below.
Advantages of Investing in Fund of Funds
Tax-Friendly: There will be no capital gains tax on this internal transaction if you want to rebalance your holdings. As a result, there will be no capital gains tax when your fund of funds is rebalanced to preserve a specific debt-to-equity proportion.
Ease of Use: There is only one NAV to track and one folio to manage. This makes it easier to manage the fewer money that need to be managed.
Professional Fund Management Services: Investing in a fund of funds allows you to test the waters with professionally managed funds before committing to individual investments.
Portfolio Manager Credibility: Because Fund of Funds requires its managers' backgrounds to be examined and validated, you may rest certain that your money is in good hands.
Access to diversified underlying assets for investors with limited money: Fund of Funds allows investors with limited capital to participate in diversified underlying assets. These assets would ordinarily be difficult for such investors to get on their own.
Disadvantages of Investing in Fund of Funds
High Expense Ratio: Fund of Funds, like any other mutual fund plan, incurs fees. However, unlike mutual funds, there is an additional expense. There is an additional cost associated with the underlying funds, in addition to the general management and administrative fees. Despite the fact that the FoF cost ratio is only 1%, as an investor, you will be charged this amount on every fund that the FoF holds.
Tax implications: If sold before 36 months, a short-term capital gain tax based on the investor's income tax bracket would apply. A long-term capital gain tax of 20% with indexation is imposed if the units are sold after 36 months.
Excessive diversification: A fund of funds invests in a number of funds, each of which invests in a variety of securities. As a result, it's possible that the Fund of Funds will end up owning the same stocks and assets through various funds. Diversification is hampered as a result.
Should you invest?
Yes, you should invest in a fund of funds if you are a novice investor with limited market expertise and a small investment budget searching for a long-term, diversified investment option with low risk. However, if you are a seasoned investor prepared to take on additional risk in exchange for greater rewards, you should invest directly in stocks, securities, commodities, mutual funds, and bonds.