When seeking to enter into the investment game, many beginners look to mutual funds as a great way to cut their teeth. At first glance, mutual funds provide an “almost” hassle-free path into the world of investing. You can get purchase a variety of investments for a relatively small amount of money. Good managers stand behind mutual funds, performing the calculations and the due diligence necessary to find the best stocks, bonds, etc. And when you’re ready to let your mutual funds shares go, you can simply sell them and take your money elsewhere. However, even with these shining advantages, mutual funds are far from being the kings of investment vehicles. Let’s take a look at the good… and bad… of mutual funds.
The first major benefit of investing in mutual funds involves it’s provision for diversification. Mutual funds pool funds in order to purchase shares of stock, bonds, etc. By investing in a mutual fund, your funds essentially become a part of that pool. Now your funds are spread over several different investments just by becoming part of the fund pool. This, in turn, spreads the risk associated with the investments that make up the mutual fund. To achieve the same effect on your own, you would have to spend a lot more building your own diversified portfolio. That may prove difficult, especially if you don’t have the expertise to create such a portfolio.
With a mutual fund, you do not have to worry about needing a lot of investment know-how. Managers of mutual funds do all the research in regards to selecting the best investments for the fund. They work diligently to craft a portfolio that minimizes the risk and maximizes the rewards through diversification. Their years of investment experience provides them with insights that a novice would simply not possess. And if you don’t like how the managers run their fund, well, you can just get out.
For some investment instruments, turning your shares into cash takes time. Mutual fund managers have a plan that makes shares in the fund much more liquid. Typically, a portion of a fund portfolio is cash specifically set aside to pay out withdrawals. When an investor decides to sell their shares in the mutual fund, their money can be returned to them quickly.
The biggest disadvantage to investing in mutual funds lies within the fee structure. Fees are paid whenever you choose to buy or sell shares. Also, for the time you own shares, you will have to pay fees associated with the maintenance of the portfolio. Shareholder and annual operating fees can eat into any profits to realize will invested in a mutual fund. They can also magnify your losses as these fees will be paid regardless of the fund’s performance.
Your second concern with investing in a mutual fund regards the fund’s management. Mutual fund managers don’t always get it right. Even with years of experience and hours of research, they may choose the wrong investment mixture at the wrong time. They may choose to heavily invest in a sector that is primed for a fall. Then, there exist those managers that have every intention of taking advantage of investors in their funds. You’re best bet is to be cautious in which mutual funds you choose to invest in and research managerial history when you find one you like.
In the quest of the mutual fund manager to minimize risk as much as possible, they may risk exposing the fund to over-diversification. A portfolio consisting of too many closely related investments may defeat the purpose of investing in a mutual fund. The value of the fund’s shares will move in accordance to the value of the investments. So if that portion of the fund takes a significant hit, then the mutual fund itself will suffer the same fate. There won’t be enough offsetting investments to cushion the blow.
Mutual funds can be an excellent choice for starting an investment portfolio. They provide an easy entry point for beginning investors to build their wealth. However, they are not perfect investment vehicles. Research mutual funds to minimize expenses and maximize value. Management styles and fees differ from fund to fund. Use mutual fund screeners like those offered by Yahoo! Finance and Morningstar to help narrow your search. Don’t rush into any investment and try to stay as informed as possible. You can only benefit in the end.