Advantages and Disadvantages of Mutual Funds
Advantages of Mutual Funds:
• Professional Management - The primary advantage of funds (at least
theoretically) is the professional management of your money. Investors
purchase funds because they do not have the time or the expertise to manage
their own portfolio. A mutual fund is a relatively inexpensive way for a
small investor to get a full-time manager to make and monitor investments.
• Diversification - By owning shares in a mutual fund instead of owning
individual stocks or bonds, your risk is spread out. The idea behind
diversification is to invest in a large number of assets so that a loss in
any particular investment is minimized by gains in others. In other words,
the more stocks and bonds you own, the less any one of them can hurt you
(think about Enron). Large mutual funds typically own hundreds of different
stocks in many different industries. It wouldn't be possible for an investor
to build this kind of a portfolio with a small amount of money.
• Economies of Scale - Because a mutual fund buys and sells large amounts of
securities at a time, its transaction costs are lower than you as an
individual would pay.
• Liquidity - Just like an individual stock, a mutual fund allows you to
request that your shares be converted into cash at any time.
• Simplicity - Buying a mutual fund is easy! Pretty well any bank has its
own line of mutual funds, and the minimum investment is small. Most
companies also have automatic purchase plans whereby as little as $100 can
be invested on a monthly basis.
Disadvantages of Mutual Funds:
• Professional Management- Did you notice how we qualified the advantage
of professional management with the word "theoretically"? Many investors
debate over whether or not the so-called professionals are any better than
you or I at picking stocks. Management is by no means infallible, and, even
if the fund loses money, the manager still takes his/her cut. We'll talk
about this in detail in a later section.
• Costs - Mutual funds don't exist solely to make your life easier--all
funds are in it for a profit. The mutual fund industry is masterful at
burying costs under layers of jargon. These costs are so complicated that in
this tutorial we have devoted an entire section to the subject.
• Dilution - It's possible to have too much diversification (this is
explained in our article entitled "Are You Over-Diversified?"). Because
funds have small holdings in so many different companies, high returns from
a few investments often don't make much difference on the overall return.
Dilution is also the result of a successful fund getting too big. When money
pours into funds that have had strong success, the manager often has trouble
finding a good investment for all the new money.
• Taxes - When making decisions about your money, fund managers don't
consider your personal tax situation. For example, when a fund manager sells
a security, a capital-gain tax is triggered, which affects how profitable
the individual is from the sale. It might have been more advantageous for
the individual to defer the capital gains liability.
contact us for
advertisement information and other matters.