It is never a good idea to put all of your money in one place. If the company does great, you will make a profit, but if the company doesn't do as well or goes bankrupt, your entire life savings will also go down the drain with it, possibly causing you to go bankrupt as well. In fact, the more you diversify your investments, the less impact each individual company or product will make on your bottom line. Buying many companies will help reduce your risk.
Mutual Funds are a great way to diversify your risk. Instead of buying hundreds or thousands of individual stocks or bonds, you can buy one fund or a handful of funds. An expert manager will choose the stocks or bonds for you, and will keep track of how they are doing, and buy and sell them accordingly.
Before making a decision, you should consider its advantages and disadvantages. Please keep in mind that you need to consider the advantages and disadvantages of the underlying investments as well.
Disadvantages of Mutual Funds
Let's start with the disadvantages.
- They charge fees. Some of the fees are openly disclosed, such as the fees for buying or selling mutual funds. But some of them are hidden, sorry the politically correct term is embedded, in the yield. Even no load funds charge fees. You are generally paying these fees throughout the term you hold these funds. These fees cover operating and management expenses, and reduce your overall return on your funds. Be sure to read the prospectus and the fine print, and specifically ask about the fees when buying them. If you had bought stocks and bonds individually, you would be holding them yourself for free, paying only the costs of buying and selling these securities.
- If you buy different mutual funds, you may find out that they are all investing in the same companies, so you really aren't diversifying by buying more than just one. Be sure to look at the list of underlying investments regularly to make sure you truly have a diversified portfolio.
- You may get lazy and depend too much on your fund manager, instead of keeping abreast of market changes.
- Many funds perform worse than the index for that type of fund, mostly because of fees and expenses. In addition, large funds may have a hard time finding a diversified portfolio that fits the criteria of the fund. All funds need to hold some cash positions in case people want to sell their positions that day, so the entire fund is not wholly invested.
- It is hard to know how well a fund is doing. Since they all invest a different amounts of securities, it is difficult to compare one fund with another. Remember, past performance is not an indication of future returns.
- Sometimes funds close up for no reason, or change their investment strategy. The fund manager may be replaced. You need to keep informed of these changes and determine how they will impact your investment.
- The expertise of the mutual fund manager varies. A disgruntled or inept fund manager can keep you from having the gains you might have had under a more trustworthy and experienced manager. Be sure to keep a lookout for manager changes.
- Some securities may be bought or sold for political reasons instead of what is in the best interest of the fund.
- Some fund managers like to buy and sell securities frequently. Since the mutual fund market is very competitive, the manager has an incentive to "do something" instead of simply buying and holding them. This may not always be the best strategy to grow your hard earned money.
- Frequent buys and sells will lead to capital gains you will have to report on your taxes each year, even in years you don't personally sell your positions.
This article was written to provide you with information and my opinions. It is not advice. It's your money. You should weigh your options and decide you what to do with it.
Advantages of Mutual Funds
There are many advantages as well.
- You can have a diversified portfolio without having a large amount of cash to invest. Because of minimums, you may not be able to afford to buy hundreds or thousands of individual securities. A fund helps reduce the risk in case one company goes belly up.
- You can rely on the expertise a trusted and experienced fund manager to buy, sell, and manage your portfolio. This expert is able to spend all day analyzing investment decisions and keeping up with industry trends. In addition he generally works with a team who can also does the same.
- Your dividends can be reinvested in the fund even though they are generally small amounts. This can help your investments grow faster.
- You don't need to learn about many different companies and keep track of their activities.
- These funds are convenient to buy and sell. You can generally buy or sell them with very few days notice. This keeps your money more liquid than they would be if you had individual stocks or bonds you needed to sell.
- You can save time of not having to keep track of so many different investments.
- The brokerage firm is likely to give you information and advice to help you decide what to do when market conditions change. Be sure to read the information provided to you about the fund, and keep track of the manager and company.
- Your brokerage firm will also be able to help you choose your portfolio of mutual funds to help diversify your investments, and answer your investment questions.
- By shopping around, you can find low or no load funds that will not charge you a great deal in fees.
- You can set up automatic withdrawals from your checking account to buy funds each payday before you get a chance to spend it, making putting money away for savings quick and easy. You don't have to remember to make the transfer, and the money is gone out of your account before you miss it.
Advantages and Disadvantages of Mutual Funds
Mutual funds can help you diversify the risk among different securities, and let you have a balanced portfolio of investments even if you don't have a large amount of money to invest. They allow you to put your money in the hands of the expertise of the fund manager, saving you a great deal of time. They are more liquid than individual securities. .But the fees can reduce your return, and incompetent fund managers can reduce it even further. By carefully choosing funds that have competent fund managers, you can create a diversified portfolio while managing your risk.
Shasta Matova (author) from USA on March 05, 2012:
Thank you Cloverleaf and teaches12345 for reading, commenting and voting. That is a good summary, good choice for diversifying with limited investment knowledge.
Dianna Mendez on March 04, 2012:
Thanks for writing this article as it will help to make a better decision when investing personal money. It is always risky when you invest, but if you do your research it will pay off. Voted up.
Cloverleaf from Calgary, AB, Canada on March 04, 2012:
I do agree that mutual funds have both their advantages and disadvantages. You have explained this very clearly and done a wonderful presentation in this hub! Personally, I invest in individual stocks (mostly dividend payers) and ETFs. I just find that the mutual fund fees are too much. But they are a great choice for investor with limited investment knowledge who want to diversify. Voted up and interesting.
Shasta Matova (author) from USA on March 03, 2012:
Thank you AudreyHowitt, molometer, alocsin, dumindu89. Buying stocks, even in mutual funds can be scary when the market goes down or the economy is uncertain, but when you have the help of a broker or fund manager, it makes it a little bit less scary.
dumindu89 from Sri Lanka on March 03, 2012:
Nice hub mate. You provided an informative answer to me.
Aurelio Locsin from Orange County, CA on March 03, 2012:
I agree with all your assessments. I think though for an investor looking for diversification and yet not knowledgeable enough about the stock market, mutual funds are a great way to go. Voting this Up and Useful.
Micheal from United Kingdom on March 03, 2012:
This was very useful and timely.
The stocks are so low at the moment, there are so many to choose from. It is a great time to buy, but who knows what will go under next.
It would be wise to find a good broker.
Audrey Howitt from California on March 03, 2012:
Great hub! It seems wise to combine in a portfolio--