What are Mutual Funds?
Mutual funds are companies that pool money together from various investors to buy and sell different securities and assets. These assets may include (but are not limited to) stocks, bonds, real estate, money markets and metals. When you buy or sell your mutual fund shares you do it straight through the company, also known as the fund family. You can get mutual funds from companies like Fidelity, Vanguard and Schwab.
Mutual Funds Pros and Cons
Every investment has a list of pros and cons that comes with it. There is no perfect investment, including mutual funds. Now that we all know what mutual funds are, what are the mutual funds pros and cons?
Pros of Investing in Mutual Funds
Diversification
When you buy shares of a mutual fund you get a diversified portfolio of individual investments. These types of portfolios can be difficult for a normal investor to manage. One pro of mutual funds is that you get your diversified portfolio without having to worry about managing it. The company does that for you. Also, you can invest large or small amounts of money in your mutual fund, which makes it a great way to invest without needing a ton of experience.
Professional Management
Mutual fund managers are typically professionals with advanced degrees in finance. They often have years or decades of experience in money management and professional licensing. In short, they usually know more about money than you.
Economies of Scale
Mutual funds typically have tens of millions or more dollars and as a result can purchase equity assets at better prices than individual investors can.
Liquidity
One great advantage of mutual funds is liquidity. That is, there is a ready market for them. This means that you if you need to sell your shares, you can expect to find a buyer within a short amount of time at the market value of units of the fund.
Cons of Investing in Mutual Funds
Not everything about mutual funds are great though. Where there are pros there are also cons. Although they are fairly easy to manage, mutual funds can be expensive to keep up. You also only get share prices once a day. If you invest in the stock market directly you get price updates continuously throughout the day.
Capital Gains
Capital gains are another potential con of a mutual fund. There is a chance with this type of investment that you could pay taxes on your mutual fund, even if you lost money on it. You have to pay taxes on your mutual fund each year, like you do any stock market investment. However, you have to pay taxes on any capital gains for the year.
Mutual Fund Taxes
Another con of a mutual fund is having to pay taxes on your earnings. You can get around paying taxes on your earnings by transferring the cash to a 401K or IRA. These types of retirement accounts can have mutual funds within them but they won’t be taxed. This is because individual investors don’t have control over when the fund generates capital gains – you pretty much need to accept what you get.
Lack of Control
When you buy a mutual fund, you are essentially hiring a money manager or set of money managers to grow your money. You do have some control of when to buy and sell your shares in the fund, but individual fund unit holders tend to have little say over when stocks or bonds within the fund are bought or sold. You also have next to no control over the amount of discipline the fund management exercises over its decisions. At any time, the fund manager could decide to switch from a growth strategy to a value strategy. This is a pretty significant downside, especially if you have a large position and fund management changes or begins to make poor decisions.
Limited Sale Times and Fees
Mutual funds buy and sell only once a day. In addition, many varieties of mutual funds carry fees. In fact, the average mutual fund charges between 1.3% and 1.5% These can include back-end loads (typically called deferred sales charges) marketing (12b-1) fees, redemption fees and management fees. You don’t have any of these fees if you directly own stocks, bonds or exchange traded funds.
Should Invest in a Mutual Fund?
Mutual funds can be a great way to invest. After reviewing the mutual funds pros and cons, you can decide whether you want to buy into a mutual fund or not. As with any investment, you should be sure to do plenty of research before investing your money.
What do you think about the mutual funds pros and cons? Would you (or have you) invest in a mutual fund?
Photo: Ed Ivanushkin
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