Are mutual funds safe? Addressing a reader’s concerns

We address a reader’s concerns about mutual fund investing. He writes, “As I continue my journey to financial independence, a few concerns have occupied my thoughts recently”.

1. Safety of Direct Investing on Mutual Fund AMC Websites “I have often contemplated investing directly through mutual fund AMC websites to minimize hassle. However, I am apprehensive about the safety and security of this approach. Could you shed some light on the risks involved and whether it’s a prudent strategy for a long-term investor?”

There are at least four ways to invest in direct plan mutual funds.

• Through AMC websites. You will need an account for each AMC if you have multiple funds.
• Through MF Utility: A single portal for most AMCs funded by AMCs
• Through MF Central: A portal maintained by the two registrar and transfer agents.
• Through private direct plan portals.

Regarding safety and security, I don’t think any option is superior or inferior to any other option. I have been invested via AMC websites for over ten years and have not faced any hassles. So, there is no reason to worry. You can choose an option suitable for you.

It must be remembered that mutual fund buying and selling is a closed loop. Units can be purchased or redeemed only via a designated bank account. Suppose someone hacks into our mutual fund account. They cannot buy or sell without two-factor authentication (this is also necessary while logging in).

Even if someone sells without our consent, the money would only reach our bank account. A bank account cannot be added or removed without paperwork. So, to steal from our mutual fund holdings, one must simultaneously control our MF account and bank account, meaning they have control of our computer and our mobile, which is improbable, if not impossible.

We suggest you use only a desktop or laptop for financial transactions and a mobile-only one for OTPs. Using a mobile for transactions significantly reduced the utility of two-factor authentication as only one device is involved. Use a good password manager, and you’re good to go.

2. Ensuring Accuracy in Accounting and Software” “When we buy mutual fund units, there’s always a concern about potential accounting or software errors, whether short or long term. What are the best practices to safeguard against such discrepancies and ensure the integrity of our investment portfolio?”

NAV is accurate up to four decimal points. Over the long term, there would be small rounding-off errors, but other than this, any mistake can easily be spotted by a simple spreadsheet check.

3. AMC Downfall Due to Fraud: “Financial institutions face turmoil due to fraud or mismanagement. In such unfortunate scenarios, how much of our investment is guaranteed by SEBI, and what steps can we take to protect our financial well-being?”

A mutual fund is a fully capital market-linked investment. This means you buy units at market price and sell at market price. There is no concept of “getting your money back” or a guarantee like an FD.

A mutual fund is designed as a trust. So one cannot easily siphon off unit holder money and run away. That said, a mutual fund can mismanage investor funds and take decisions or risks not stated in the scheme document. There are reasonable safeguards against this, but nothing is foolproof. Also, see: Can Mutual Funds Fail (go bust) Like Banks?

We can trust SEBI to live and learn from past experiences. Although that is cold comfort for those affected by a crisis, SEBI has iteratively reduced management risks in mutual funds.

Investors can reduce this risk by investing across AMCs. Beyond that, it is up to providence. We cannot get stymied by worrying about every possibility beyond our control.

Mutual funds are reasonably safe to invest. That is good enough for me.