Mutual Funds
Mutual funds are a type of family investment where a professional manages your money and how/where you invest it. These fund managers pool the money you and other investors have given them and invest in a mix bonds, money market accounts, stocks, and other investments by purchasing new shares of the mutual fund. In other words,
- Shares of the mutual fund are created for the investor
- These new shares are issued to the investor
- The new investor’s dollars are combined with dollars of the other mutual fund holders
- Portfolio manager buys investments in accordance to the investors wants and needs
The result is that the investors, who only gave the manager a small amount to invest, has access to an extremely diverse portfolio with a large growth potential that is professionally managed. Even though it sounds confusing, more than 80 million people, or half of the households in America, invest in mutual funds.
So what is the pull of these mutual funds, and what makes the best mutual funds? Why invest in mutual funds rather than a 401k plan or Roth IRA? Following are the pros and cons of why a family should invest in mutual funds.
Top Benefits of Mutual Funds
- Investment Diversification
- Professionally Managed Portfolios
- Various Type of Mutual Funds
Investment diversification helps to prevent your family investments from depleting. If one area of your investments starts to plummet, the other areas are safe and can still thrive. One of the best ways of adding investment diversification is by adding stocks of different market caps (large, mid and small cap) and various types of bonds (ranging from municipal bonds to corporate bonds). Mutual funds allow this diversification instantly and with low amounts of investment needed.
Having your portfolio professionally managed might be slightly more expensive than doing it yourself, but will save you countless hours of trying to understand the different meanings of different stocks, but can in theory make you thousands more from your investments.
No matter what you need to add to your family investments to get the greatest profit, participating in the various types of mutual funds can get you there.
Top Disadvantages of Mutual Funds
- Management Abuses
- High Expense Ratios and Sales Charges
- Tax Inefficiency
Although you have the advantage of having someone who is knowledgeable about the stock market handling your expenses, the truth of the matter is that you always have to be careful. When other people handle your money, and your assets, there is always a chance of someone taking advantage and abusing the system. Churning, turnover and window dressing are the most common forms of mutual fund management abuse and also includes unnecessary trading, excessive replacement and selling the losers prior to the quarter-end.
There is a lot of technical jargon that goes along with mutual funds, including terms like expense ratios and sales charges. Make sure you know what these terms mean, and keep an eye on them! Mutual funds with expense ratios higher than 1.20% are considered to have a higher cost end, which means they are something to keep an eye on if your manager invests your funds into them.
Tax inefficiency becomes a problem because the managers do not have a choice on capital gain payouts. There are several factors that contribute to getting distributions from mutual funds that are taxed uncontrollably. These include turnovers, redemption, gains/losses in security holdings throughout the year, and more.
