Mutual funds are often labelled as the simplest path to wealth creation. But that simplicity translates into results only when the fund aligns with your financial goals and risk appetite. Not every mutual fund is worth your investment. Some are better avoided due to high costs, limited transparency, and poor performance potential.
Finology Research Desk has identified such mutual fund categories and provided their insight on why IT’s smarter to avoid these options.
1. Sectoral / Thematic Funds
Sector-specific funds like pharma, IT, or infrastructure require deep macro-level analysis to understand industry trends, government policies, and economic conditions. SIPs usually do not work well in these funds unless the sector is steadily growing.
It just keeps adding to a weak position if the sector underperforms. Even lump sum investing needs accurate market timing to enter before the sector gains momentum and exit before it becomes stagnant, which is extremely difficult for most retail investors to judge precisely.
These funds also charge high expense ratios, usually above 1.8 per cent. Despite that, as per ICRA, around 43 per cent of sectoral and thematic funds have underperformed their benchmarks in the past year. So you end up taking unnecessary risks without getting better returns.
2. Solution-Oriented Funds (Retirement and Children’s Plans)
Compared to solution-oriented mutual funds, options like the National Pension System (NPS) for retirement, Sukanya Samriddhi Yojana (SSY) if you have a daughter below 10 and Public Provident Fund (PPF) for a boy child or long-term savings, offer several advantages like tax benefits, government backing at much lower costs.
Solution-oriented funds typically charge expense ratios over 1.75% annually, which steadily erodes long-term returns, whereas NPS charges less than 0.09% annually and SSY and PPF have no annual fees. Over the past five years, most solution-oriented funds with over 75% equity allocation have underperformed key benchmarks like the Nifty 500 TRI, Nifty 100, and even large-cap or flexicap fund averages.
3. New Fund Offers (NFOs)
AMCs aggressively promote New Fund Offers (NFOs) not for your benefit but because they’re highly profitable for them. These funds allow AMCs to charge higher expenses, often justified by the low initial AUM, and easily attract new inflows. But for investors, it doesn’t offer any meaningful benefit.
With no performance history to evaluate their potential, investing in them is basically like a blindfold. Furthermore, most NFOs are not very different from existing schemes but only carry unnecessary risks.
4. Hybrid Funds
Hybrid funds are marketed as an easy way to reduce volatility by combining equity and debt in a single fund. These funds charge higher expense ratios, usually between 1.5% and 2%, which reduces your returns significantly in the long term. You can build separate equity and debt portfolios at a lower cost.
For long-term goals like wealth creation or buying a house, equity funds work better. For short-term needs like a gadget purchase or a vacation, debt funds, especially liquid and overnight funds, are more suitable, making hybrid funds unnecessary.
5. Debt Funds (Excluding Overnight or Liquid Funds)
Many influencers portray debt funds as the safest investments, often comparing them to fixed deposits. However, this comparison can be misleading. In reality, debt funds are exposed to risks such as interest rate volatility, credit defaults, and liquidity crunches.
For short-term goals, options like overnight funds, liquid funds, or bank FDs generally offer more stability at a lower risk.
6. Fund of Funds (FoFs) / Feeder Funds / International Funds
These funds invest in other mutual funds, including international ones and charge fees at two levels: the fund’s expense ratio (1–2%) plus fees of underlying funds (0.5–1%), which significantly reduces your returns over time. These “fund of funds” also lack transparency regarding their holdings, making it difficult for investors to know exactly where their money is invested.
These are mainly meant for diversification at the institutional level. To get real diversification benefit, it typically requires at least 20–30% investment in international funds. But as a retail investor, you have plenty of other options to diversify your portfolio, such as gold, without adding unnecessary international exposure.
As per Finology Research Desk, 68 international mutual fund schemes in India have delivered an average return of just 7.7% over the last 10 years, which barely justifies anything.
7. Large-Cap Active / Mid-Cap Active Funds
In the large-cap segment, SEBI mandates funds to invest only in the top 100 companies by market cap. This limits fund manager flexibility and makes it hard to generate significant alpha. Similarly, mid-cap funds are also restricted to 150 stocks and face higher volatility.
As per Finology Research Desk, over the past 5 years, around 60% of active large-cap funds and 67% of mid-cap funds have underperformed their benchmarks. Given these constraints, smarter options like large and mid-cap funds or large-cap index funds often deliver better post-fee returns.
8. ELSS Funds (Under the New Tax Regime)
The main attraction of Equity Linked Savings Schemes (ELSS) was the ₹1.5 lakh tax deduction available under Section 80C. However, under the new tax regime, this benefit is no longer available. What remains is a compulsory 3-year lock-in that restricts liquidity, without any accompanying tax relief. ELSS will only be beneficial if you are opting for the old regime and actively claim the deduction. But if not, there is no point in investing in ELSS.
9. Regular Plans and Dividend Distribution (IDCW) Funds
Regular plans: Many investors still choose regular plans without realising they pay an extra 0.5–1% annually in distributor commissions. For example, if you had invested ₹10,000 per month in a flexi-cap equity fund, based on 10-year average returns, the difference in final value between direct (15.34%) and regular plans (14.22%) would be substantial, which quietly erodes your returns in the long term.
Dividend plans (IDCW): Dividend plans may seem attractive due to regular payouts, but they are tax-inefficient as these schemes are taxed at your slab rate and interrupt compounding by reducing reinvestment potential. In contrast, a growth plan reinvests your money and provides better compounding benefits over the long term.
Conclusion:
Finology Research Desk believes that if your goal is wealth creation, prioritise low-cost index funds or reputable flexi-cap funds with proven track records.
Low-cost index funds offer broad market exposure without the guesswork of stock-picking, while flexi-cap funds add value by allowing fund managers to shift across equity market caps, debt based on where they find potential opportunities, providing a balance of flexibility and diversification. These options can help you grow your money without taking on unnecessary complexity and risk.
What matters most is picking investments that suit your risk appetite and long-term goals. Don’t get distracted by hype or complexity that adds little value.
Finology is a SEBI-registered investment advisor firm with registration number: INA000012218.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.