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Investing in Mutual Funds: Some Advantages and Disadvantages

Updated on July 13, 2012
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Investing in Mutual Funds: Some Advantages and Disadvantages

Being an investor, a financial adviser and an investment advisor, I highly recommend mutual funds as the best place to start building wealth. Investing in mutual funds is a great way to build wealth the proper way, for the proper investor who has a solid financial plan and knows what he or she wants to achieve. Mutual Funds have been around for a long time and probably will stay around for a long while. Discussed are some key fundamental advantages that mutual funds have to offer, and some disadvantages that are worth being cautious about.

Professional management

Professional management is one of most significant advantages of a managed mutual fund. The fund manager and the staff of the management team usually are better equipped and have a lot more time and money to leverage when researching investment opportunities. Rarely do individuals have the time, knowledge, or resources to compete with these professionals. When an individual has a very limited amount of time and money, it is usually never cost effective to do quality research. Even if an individual investor is very knowledgeable not always will prospects be accommodating to the investor’s inquiries and questions, for example it wouldn’t be unusual for a CEO or a President of a large company to not respond to an individual investor who only has $10k to invest. The fund manager who has $50 - $100 million would be treated differently for obvious reasons. Money in bulk would go a longer way because it would be more cost effective to more and better research and analysis of investment opportunities. The professionals when well funded could talk to the whole management chain, the supply chain, manufacturing chain, and even to competitors if they wish and have full cooperation, while an individual investor would be left out. Professionals in short are more able to go the distance with their due diligence.

One other thing that is great about mutual funds with a small account the small investor has the same portfolio manager as the millionaire who has the very large account. The money is in the same pot and the so the expenses and profits are split proportionally. Which is awesome, nobody gets favored inside the fund; everyone shares the costs of management fairly.

Diversification

It is generally agree that diversification is the most important advantage to investing in mutual funds. As the old saying goes “don’t put all of your eggs in one basket”, certainly that concept greatly applies to the world of investing. There certainly are benefits to of diversifying one’s portfolio assets and mutual funds are probably the easiest way to accomplish that. With a small investment the investor’s money obtains access to a diversified portfolio. Even though the fund may not be classified as a “diversified” fund because of regulations, never-the-less the assets of the fund are better spread out than the individual small investor could often do alone. Diversification is super important and used to minimize risk. Different industries have different risks and cycles and having assets invested in different sectors, countries, and currencies is a good idea. Although diversification does help in reducing risk, it will never eliminate all of it.

Convenience

With mutual funds, buying/selling shares, changing different options, getting information can usually be accomplished by going online, call a toll-free number, or through the mail. Managing hundreds of individual stocks would be a much bigger hassle for most investors who simply dot have the time for the day-to-day tasks of managing a portfolio through researching, buying, and selling investments. However even if the investor is relieved of much of the work, evaluating the mutual fund on the basis of investment goals and risk tolerance before investing is still critical. It is advisable to read the prospectus carefully to find the necessary information to make an educated decision.

Liquidity

As Dave Ramsey puts it in a course I highly recommend, The Financial Peace University, liquidity equals availability. Without getting too technical securities law requires the mutual fund company to be ready to redeem shares at what is called NAV or net-asset-value per share and to make payment within seven (7) days of the request. Although there could be a redemption charge and between the time of request and the valuation of the NAV some price fluctuations may occur, liquidity still promised. So unlike other investments there is always a customer for your shares, the mutual fund. Other investments might be un-sellable for a while for many reasons, but not with a mutual fund.

Minimum Investment Amount

As already mentioned it doesn’t take much assets to start investing in mutual funds, investors who are just starting out can start contributing as low as fifty dollars ($50) a month to their mutual fund account. And often mutual funds are less expensive to invest in, especially when considering all of the benefits. For example if an investor starts out with the mentioned fifty dollars ($50) per month and pays a sales charge of five percent (6%) the cost of investing would be about three dollars ($3) vs. a trading fee of six to ten dollars ($6 - $10) in a brokerage trading account. Relative to all of the benefits received in a mutual fund the costs are very competitive.

Disadvantages to Mutual Funds are there any?

Yes of course there are always trade-offs and every investor should know what they are.

Risks

Market prices fluctuate, and regardless how well diversified the portfolio and how well the fund management picks the investments; there is always the possibility of losing money due to different factors. As mentioned before diversification does help in reducing risk but it will never eliminate all of it. Stocks in a mutual fund have market risk, bonds in a fund are subject to interest rate risk, and international funds have currency risk and political risk, and so forth. These risks of course are not specifically limited to mutual funds, they also can apply to the individual investments as well, and therefore this isn’t exactly a specific disadvantage to just mutual funds.

The best way to mitigate losses would be to have emergency funds set aside in order to not have to withdraw money out of the fund and depleting it at an accelerated rate.

Fees and Expenses

Investors should always consider the fees and expenses involved with investing in any particular mutual fund. Those include sales charges, fees known as 12b-1 fees, and any possible fees for redeeming shares. Ongoing management fees are often the biggest expense. All of the managers and analysts have to be paid; their research often incurs travel and housing expenses. All the previous benefits mentioned in the article have a cost that an investor should consider.

In summary, as an advisor I believe the benefits of investing in mutual funds totally outweigh the costs. I hope that I have answered some questions, if I by chance created more questions as a result of answering some, please don’t hesitate to ask.

Full disclosure: The author is currently invested in Legg Mason and Franklin Templeton mutual fund families for both clients and personal accounts.

Disclaimer: Any discussion here is for general education purposes only. Past performance is not a guarantee of future results. Investors should not rely on the opinions of the author as a statement-of-fact or make investments in any of the funds mentioned without first pursuing their own course of research and determining whether their own risk tolerance and goals align with the stated objectives of the products themselves. A please don’t forget to have a wonderful day. Thank you.

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