Advantages of Mutual Funds

Mutual funds are a popular investment instrument during the last centuries for people who want to reach a higher return than a traditional savings account. Investing in mutual funds is easier than investing in stocks and you don’t need a great capital to diversify your investment portfolio.

Here are some advantages which may help decide to invest in mutual funds:

1. Diversification

Diversification can be considered as the main raison to invest in in mutual funds. A good investment strategy requires diversification of your investment portfolio. Diversification limits the risk of losing money if the value of some assets will drop; probably some others will rise.

If you buy stocks you need a large capital if you want diversification in your portfolio. Investing in mutual funds is easier to diversify and gives the possibility to invest in 100 individual companies or even more with one purchase. The risk is fewer compared with buying individual stocks and most people don’t have the capital to make such diversification with individual stocks.

Maybe it is best to buy different kinds of mutual funds for limiting the risk. For example, if you buy a mutual fund in the financial sector and there is a crisis in the financial sector your portfolio will likely suffer. When you have mutual funds of different sectors in your investment portfolio you will limit the risk because other sectors may have better returns.

If you want to buy only one mutual fund it is best you choose one where you diversify in stocks, bonds and other assets and according your risk profile. There are mutual funds for the aggressive, balanced and defensive investor. If you are willing to take more risk you best choose a mutual fund of the aggressive investor (100% in shares); if you will limit the risk maybe it is preferable to buy a mutual fund which invest for 50% in stocks and 50% in bonds (balanced investor) or 25% in stocks and 75% in bonds (defensive investor)

2. Knowledge and management

Mutual funds have the advantage of professional management. You don’t only buy a mutual fund but also a manager who takes care for the money you have invested in that fund. He buys and sells stocks and bonds for reaching the highest return according the investment strategy of that mutual fund. You don’t need the knowledge which you need if you invest in individual shares; your professional money manager is an expert in the financial world. It is always useful to have some knowledge for understanding the investment strategy.

3. Low investment minimums

You can already buy one unit of a mutual fund for $100.00 or even less but you can invest into mutual funds for lower amounts. It is even possible to invest in mutual funds for amounts less than $30.00 but most banks ask monthly contributions if you choose for this system. It is always wise to check the costs if you invest for low amounts into a mutual funds.

Investing in mutual funds through systematic investment plans is a popular system if you want to build up a large capital after several years. It is a safe system because you don’t invest always into your mutual fund on a high price. The average purchase price of your investment in your mutual fund is much lower because you never know if you buy on a peak price or not.

4. Low transaction costs

Mutual funds have lower transaction costs than individual stocks if you invest for smaller amounts. In general the purchase fees of mutual funds are 2% but there are differences between the types of mutual funds and it varies from country to country. If you invest a low amount in individual stocks the fees can be 20% or even more. You need to pay a fixed amount of costs no matter how many stocks you buy. The average cost is lower if you invest for example $2.500 compared with lower amounts.

4. Convenience

If you invest in mutual funds you don’t have to worry about tracking an endless list of individual shares; you only need to consult the value of your mutual funds and keeping an eye on the return of your mutual funds.

5. Liquidity

Liquidity is maybe one of the greatest advantages of mutual funds. You can sell your mutual funds at any time and you can redeem your money on demand. It is easier compared with stocks. The bid-ask spread and volume are important for the liquidity of stocks. CD’s offer no liquidity at all and also bonds can be difficult.

Liquidity is especially important in fallen markets and that is the great benefit of investing in mutual funds. You will redeem your money almost after two days dependent on the type of your mutual fund.

6. Lower risk than stocks

The risk of investing in mutual is much lower than investing in stocks. If you invest in stocks a company can go bankrupt. A mutual fund can never go bankrupt because you invest in different companies. It is important to know some mutual funds have more risk than other and diversification in mutual funds is necessary, for example mutual funds in growing markets have more risk than for example sector mutual funds or a mutual fund which invest in a mix of bonds and shares.

However, mutual funds have a lot of advantages; there are always certain risks. Market fluctuations have always an impact on the return of your mutual fund and it is wise to be informed about the risks, the fees, the possible penalties for early withdrawal before you consider buying mutual funds.

It is necessary to take your time and understand mutual funds are long-term investments. Invest only with money you don’t need in the next five to 10 years and don’t rush for investing in mutual funds because someone gave the advice you would miss a great opportunity; maybe you buy on a peak price and you can best consult more people before you take the step to buy a certain mutual fund.

A good investment strategy requires time, patience, research and don’t take more risk than you can afford. Your investment profile is the key to have success.