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Tax Free Mutual Funds, Lock-in Period, Interest Rates & Benefits.

One must understand that Equity mutual funds means stock market by proxy. When you buy a unit of mutual fund, you are buying a small basket consisting of very small portion of different shares that the particular fund has purchased. So a mutual fund investor is in reality an investor in the stock market. In the long run, theoretically speaking, mutual fund should give a return more or less equal to the market return. In the short run, the divergence between stock market return and the mutual fund return is because of selection of different shares in their basket as compared to the shares in the market basket.

Historically over a long period of time stock market has given much higher return than the fixed income instruments. However this may hold true only in the long run, in the short run market idiosyncrasies and noise determines the price. The risk reward ratio in the stock market is high which means that while you take a high risk, the reward potential is also high (high risk means that if the spiral works against you, it may wipe off your capital too).

In comparison, fixed income securities are fairly stable, and their return predictable with mathematical accuracy. But, they do not offer the kind of appreciation that stock market may offer.

Having explained that, it is for an individual to decide which would be a better investment for him. A judicious mix of the two is suggested, so that you can take advantage of capital appreciation from your mutual fund investment, and continue to get a fixed return on your fixed income securities. What is the right mix for you will depend upon your risk appetite, and investment time-frame.

Source: The Hitwada