For investors with limited time to spend watching the ups and downs of the markets, mutual funds offer a good alternative. Here are a few reasons to give up individual stock picking and turn to mutual funds.
Diversification
One golden rule of investing for both large and small investors is to go for asset diversification. That involves reducing the risk to your assets by buying a mix of stocks from different industries and investments of different types. For example,buying both retail and industrial stocks reduces the impact on your portfolio of a poor quarter in one of those sectors. And putting some of your money in bonds protects you from a precipitous drop in stocks.
Key Takeaways
- Mutual funds offer diversification or access to a wider variety of investments than an individual investor could afford to buy.
- There are economies of scale in investing with a group.
- Monthly contributions help the investor's assets grow.
- Funds are more liquid because they tend to be less volatile.
- The investor gets professional investment management services.
To achieve a truly diversified portfolio, you would have to buy several stocks of companies in various industries plus bonds with different dates of maturity from several issuers. Such a wide selection is beyond the reach of most individual investors. By purchasing mutual funds, you get instant diversification.
One caveat, however, is that you might not get adequate diversification by investing in a single mutual fund. Don't put all your money in a single sector-specific or industry-specific fund. An oil and energy mutual fund might spread your money over 50 companies, but if energy prices fall, your savings will suffer. Instead, look for a fund that will spread your assets among several leading industries. You'll take advantage of pop in any one of them while avoiding a big hit if one sector has a rough year.
Economies of Scale
The easiest way to understand economies of scale is to consider the volume discount. In many stores, the more of a product you buy, the less it costs. A dozen donuts can be cheaper per donut than buying three. This also occurs in the purchase and sale of securities. If you buy one share of stock, the transaction fee will be the same as if you bought 1,000 shares. That's a hefty bite out of your investment in one share, but a negligible nibble out of 1,000 shares.
Fees vary widely. Read the fine print to understand what fees you will pay for investing in the fund.
Mutual funds take advantage of their buying and selling volume to reducetransaction costs for their investors. When you buy a mutual fund, you diversify without paying the 10 to 20 transaction fees that would give you a similarly diverse individual portfolio. And that's just the initial purchase fees. Take into account the transaction fees for every modification to your portfolio and the costs add up.
Divisibility
The owner of a mutual fund can invest a regular round sum every month, say $100 or $200. That gives the investor another tiny bite of many assets. A stock-picker, by contrast, might get one or two shares of stock, with an odd number of dollars left over. Or the investor can save up for many months to get one share of Amazon.
These periodic investments in a mutual fund also allow the investor to take advantage of the benefits of dollar-cost averaging, a strategy that cushions a portfolio from the impact of price volatility.
So, rather than waiting until you have enough money to buy higher-cost investments, you can get in right away with a mutual fund. This choice provides an additional advantage: liquidity.
Liquidity
An investor who is hit with a financial emergency might have to sell out in a hurry. That can be disastrous if the assets have taken a hit at the wrong moment. It tends to be less so in mutual funds, which swing in value less wildly because of their diversification.
Watch out for any fees associated with selling, including back-end load fees, which are percentages deducted from your total when you sell the fund. Also, note that mutual funds, unlike stocks and exchange-traded funds, transact only once per day after the fund's net asset value is calculated.
Professional Management
When you buy a mutual fund, you also are choosing a professional money manager. This manager makes the decisions on how to invest your money, based on a good deal of research and an overall strategy for making money. Only you can decide whether you are more comfortable with that than with making the decisions on your own.
The Bottom Line
If you decide to forego stock-picking and go with a mutual fund, you still have one last investment decision to make, and that is which fund to buy. There are thousands of them out there.
Read the prospectuses until you find one that matches your attitude toward risk-taking or risk-avoidance. Read the fine print to understand what fees you will pay for investing in the fund, as they vary widely.
Finally, understand going in that even mutual funds experience market fluctuations and may even provide returns that are below the overall market.
FAQs
Mutual funds offer diversification or access to a wider variety of investments than an individual investor could afford to buy. Investing with a group offers economies of scale, decreasing your costs. Monthly contributions help your assets grow. Funds are more liquid because they tend to be less volatile.
What are the advantages of mutual funds? ›
There are serval benefits of investing in mutual funds, including professional management, diversification, liquidity, low cost, tax benefits, affordability, safety, and transparency. However, investors need to consider several factors before investing in mutual funds.
What are the advantages of mutual funds quizlet? ›
Mutual funds offer many benefits. Some of those benefits include: the ability to invest with small amounts of money, diversification, professional management, low transaction costs, tax benefits, and the ability to reduce administrative functions.
What is the most important advantage of a money market mutual fund ____________? ›
Money market mutual funds provide investors with liquidity. That's because these funds are invested in securities that mature in short periods of time and can be liquidated for cash.
What is the advantage of investing in a fund of mutual funds? ›
Low Cost — An important advantage of mutual funds is their low cost. Due to huge economies of scale, mutual funds schemes have a low expense ratio. Expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the fund's daily net assets.
What are the advantages of investing in mutual funds known as country funds? ›
A country fund can typically exhibit high returns because of its concentration, but this comes with price volatility and increased risks, particularly in emerging market countries. Country funds are opposite to global funds, whose investment portfolios consist of securities around the globe, providing diversification.
What are the functions of mutual funds? ›
The primary function of a mutual fund is to pool money from multiple investors and invest it in a diversified portfolio of securities, aiming to generate returns and spread risk across various assets.
Which advantages do mutual funds claim to provide? ›
However, in reality, they are pretty simple in their investment philosophy and offer investors a host of benefits such as diversification, professional money management, economies of scale, transparency, and liquidity, to mention a few.
What is the primary advantage of mutual funds group of answer choices? ›
Answer and Explanation:
mutual funds allow people with little money to diversify. Diversification is enhanced through the exposure of a multitude of stocks. It offers investments in assets such as cash and bonds.
What advantages do the mutual funds offer compared to the company stock explain? ›
Buying stocks means buying an ownership share of a single corporation, representing a very specific asset. A mutual fund, on the other hand, combines many different assets—including individual stocks—into one grouping. They tend to be less volatile and risky than individual stocks. Another key difference is fees.
Fund of Funds Advantages
Investing in a FOF gives the investor professional wealth management services and expertise. Investing in a FOF also allows investors with limited capital to tap into diversified portfolios with different underlying assets. Many of these would be out-of-reach for the average retail investor.
What is so special about mutual funds? ›
Mutual funds let you pool your money with other investors to "mutually" buy stocks, bonds, and other investments. They're run by professional money managers who decide which securities to buy (stocks, bonds, etc.) and when to sell them. You get exposure to all the investments in the fund and any income they generate.
What is one advantage and one disadvantage of a money market mutual fund compared with a savings account? ›
Key Takeaways
| Money Market Fund | Savings Account |
|---|
| Requirements such as an initial amount and minimum daily balance maintenance | Usually | Sometimes |
| Charges management fee | Always | Not usually |
| Interest rate | Variable | Variable |
| Insured up to $250,000 | Yes | Yes |
4 more rowsMutual funds come with many advantages, such as advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing. Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.
What are two advantages and disadvantages of mutual funds? ›
Mutual funds have pros and cons like any other investment. One selling point is that they allow you to hold a variety of assets in a single fund. They also have the potential for higher-than-average returns. However, some mutual funds have steep fees and initial buy-ins.
What are two main reasons you would invest in a mutual fund? ›
There are several specific reasons investors turn to mutual funds instead of managing their own portfolio directly. The primary reasons why an individual may choose to buy mutual funds instead of individual stocks are diversification, convenience, and lower costs.
Is it good idea to invest in mutual funds? ›
Mutual fund investments when used right can lead to good returns, keeping risk at a minimum, especially when compared with individual stocks or bonds. These are especially great for people who are not experts in stock market dynamics as these are run by experienced fund managers.
What are the risks of mutual funds? ›
All funds carry some level of risk. With mutual funds, you may lose some or all of the money you invest because the securities held by a fund can go down in value. Dividends or interest payments may also change as market conditions change.
Are mutual funds better than stocks? ›
Mutual funds or stocks—which one offers more security? Mutual funds typically offer more security compared to individual stocks because they spread investments across various assets, reducing the impact of market fluctuations. However, the level of security depends on the specific mutual fund or stock chosen.
Do mutual funds give negative returns? ›
When Mutual Funds are providing negative returns, there are a few things one should keep in mind: Always keep the investment objectives in mind. Short-term market or NAV volatility should not affect the investments. Every few years, markets go through uptrend and downturn cycles.
