Characteristics of Mutual Funds

As with anything in life, there are always two sides to the story, cons and pros. Mutual funds are no exception. Here are a few main differences between mutual funds and other investments.

Mutual funds vs. Individual securities (stock/bond)

Mutual funds are more diversified. The good thing is that you will potentially experience less volatility, but at the same time you will potentially have slower growth. By the way, if you are buying a technology mutual fund, it does not mean that you have a diversified portfolio. It will only be a diversified technology portfolio, hence if sector takes a hit so will you. (I am sure you knew it but just in case)

Mutual funds are traditionally priced once a day. This will limit your ability to sell and limit your loss if market takes a huge dive during a day. But then investing in mutual funds is a long-term way to invest. If you are looking for a diversified fund but with the ability to liquidate pretty much at any time during business hours, ETFs are a way to go.

Mutual funds are not always tax efficient. Last year was probably a good example for some. Before market crashed in Q4, 2008 some managers were doing well and realizing capital gains. At the end of 2008, some investors’ funds lost a lot of value but they still got stuck paying tax for those capital gains. With individual securities, you realize a gain/loss only when you sell your position.

Mutual funds are managed by professionals and many of them utilize a certain amount of discipline, such as don’t sell when everyone is panicking and the other way around. This to some extent forces an investor to not to try to time the market, which is always a bad idea.

It is my personal belief that it is possible to make money in every sector/asset class. The problem with many of us (investors) is that we get emotional and change our investment direction too frequently, even though we know this is not a good way to invest. Having a mutual fund takes that emotion out of the equation, to some extent.

Mutual funds offer different fee payment options – front load, back end if held for less than a certain amount of time or no load, but those do tend to charge higher annual fees. Basically, you are likely to pay the same amount of fees but the main difference is how often, how much and when the fees are taken out taken out.

Last but not least, mutual funds are a great way to gain broad exposure or a more concentrated exposure to a certain asset class/sector… but with less investment amount required. If you wanted to have a diversified portfolio of stocks such as GE, AT&T and GOOGLE, you probably would need $tens of thousands. With mutual fund you can get it all and more with $500.

Overall mutual funds are a good investment and my personal suggestion is to use mutual funds for your core equity/fixed income allocation and build upon them with individual securities to give you more juice if needed.