Last Updated on March 22, 2021 by Filip Poutintsev
If you are new to the investment portfolio, you will begin to notice that mutual funds are one of the most popular investment strategies. And if you’ve heard of mutual funds, you‘ve probably also heard that they can be smart investments for almost any investors out there.
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Understanding the Basics of Mutual Fund
Simply put, these are investments that pool together the money collected from multiple investors to purchase securities like stocks, bonds, money market instruments, and other assets.
Although the area of investments is diverse, they don’t require a lot of money to get started. These funds are actively operated by professional money managers and they allow you to be confident with your cash.
Today, over $18 trillion of assets are held in mutual funds, and It is a chance for you to purchase stocks in healthcare companies, automakers, or your favorite tech giants. However, If you’re thinking of investing in these, it’s better to take a look at their advantages and disadvantages first.
Advantages of Mutual Funds
There are numerous reasons why they have been the retail investor’s choice for decades. Let’s break down the details of a few.
Mutual funds don’t just involve investing in a single asset. The fund manager always invests in more than one asset class; stocks, bonds, money market instruments, etc to have a share of risk. When one asset class doesn’t perform well, the other can easily compensate to avoid investor’s loss.
2. Expert Management
A mutual fund doesn’t require investors to do research and asset allocation. The fund manager takes care of it all and makes a decision. He/she decides whether to invest in debt or equities and whether to hold them or not. Before you choose a mutual fund, it is better to know about the fund manager’s reputation in fund management.
This investment option is easy to understand and buy. They usually have low minimum investments and are traded only once per day. You could pick zero-load mutual funds with fewer expense ratios that fit in your budget and goals. The expense ratio is the fee for managing your fund; it goes to the fund manager.
Liquidity is the ease of converting an asset to cash. When working with mutual funds, there are higher levels of liquidity because there is an option of daily trading. It is relatively easier to buy and exit a mutual fund scheme.
It requires no experience or knowledge of economics, financial statements, or financial markets for you as an investor. They enable you to own a professionally managed portfolio despite you not having any knowledge of investing concepts and strategies. So, they are simpler than other investment strategies.
Disadvantages of Mutual Funds
There are upsides and downsides to each and every investment vehicle and mutual funds are no different. Let’s take a look at some of the disadvantages of mutual funds.
1. High Fees
There are a variety of fees that may be associated and there is a chance that mutual fund expense ratios and sale charges could go out of hand. It is better to be very cautious when investing in funds with expense ratios higher than 1.20%. In general, be aware of the advertising fees and sales charges.
2. Tax Inefficiency
Whenever a fund manager sells a security, a capital-gains tax is imposed. Due to management’s activities, mutual funds typically generate higher capital gains. Investors don’t have a choice when it comes to capital gains payouts.
Due to the turnover, redemptions, gains, and losses in security holdings throughout the year, investors typically receive distributions from the fund that are an uncontrollable tax event.
3. Lack of Control
There is very little control when investing because the manager dictates everything. The moment you start investing in these funds, you are giving all of your power to the money manager who runs your portfolio.
4. Sets Value Just Once Every Day
Even though it has more liquidity than other choices, the immediate gains are still less than that of a stock investment. The price of a fund share is just calculated once per day while the value of a stock is updated frequently.
Since mutual funds are easy to understand and tailored to your goals, they are known to be a smart investment choice for the majority of savers and investors. However, they are not for everyone and investors should be careful to select the best funds that align with their goals and risk tolerance.