Mutual Funds Pros and Cons List
Figuring out how to invest your money can be a daunting task. There are many different factors that determine how your investment performs. Identifying these factors and learning how to navigate them in order to maximize your profits can be time consuming.
One way to increase your standing in the investment world is to invest more money. Unfortunately, for many people, this simply isn’t an option. One way to increase your buying power is to invest in mutual funds. Mutual funds pool money from different investors which allows people to diversify their holdings for a lower price than investing in each security separately.
Mutual funds can be very beneficial to your financial security, but there are also pitfalls that need to be examined and planned for. Before you decide to invest your money in a mutual fund, take a look at the following pros and cons.
The Pros of Mutual Funds
The more diverse your investments are, the more secure you are financially. If you have all of your investments in one security, then you are in trouble if that security performs poorly. Mutual funds allow you to pool your resources with others so that you can afford to purchase more securities. This means if one security performs poorly, it will not affect your overall financial standing nearly as strongly.
2. Expert Management
As previously mentioned, there is a lot that goes into managing investments. Most people who try to manage their own portfolio are working off of incorrect knowledge garnered from unreliable sources. Mutual funds are managed by financial experts who understand the market and know how to manipulate it in your favor. This means less work for you and a greater pay off as well.
3. Reinvestment Ease
Usually, when you want to purchase additional shares of a company that is doing well, you will have to pay a transaction fee on top of whatever money you decide to invest. Mutual funds allow you to reinvest the interest earned through your portfolio without paying transaction fees. This makes it easy for you to take advantage of a security that is performing well to grow your portfolio without costing you any additional money.
4. Low Cost
Investing is expensive. Companies that are performing exceptionally well can also sell their shares at exceptional prices. Some of the fastest growing companies are charging around $120,000 per share. That makes it almost impossible for individual investors to get a piece of that company. Mutual shares, however, give you the ability to buy in on a share for around $50 per month.
The Cons of Mutual Funds
1. Lack of Control
Mutual funds are managed by money managers. When you buy in to a mutual fund, you give all control of your money over to these managers. They make the decisions on buying and selling, using your money pooled with other investors to increase their buying power. While you can always decide to sell your shares and pull out of the mutual fund, you cannot control what decisions the managers make.
Investors are taxed on the gains that they make from their portfolio. In a mutual fund, this means that you are taxed anytime the fund sells individual holdings for a profit, even if you do not sell your shares. In some mutual funds, this is not an issue as there is a very low turnover in shares. Other funds that sell shares often could end up being taxed annually.
3. Over Diversification
A diverse portfolio is a good thing, but it can be a double edged sword. If a security loses money, it will have less of an effect on your financial standing if you have invested in many different securities. It is important to keep in mind, however, that the reverse is also true. If one security is performing exceptionally well, you will reap less of these benefits if you are over diversified. While this minimizes the risk, it also minimizes your opportunities to make money, sometimes negating the reason you entered the market in the first place.
4. Cash Drag
Mutual funds need to keep cash on hand in order to satisfy investors who decide to sell their shares. They also need money to be freed up for additional purchases. Unfortunately, because these funds are not actively invested, they are not in a position to make any money. Investors still need to pay fees on these funds, though, because all funds are counted when annual expenses are calculated, including any funds not currently invested. This can add up to a significant loss in portfolio value over time.
There are many different mutual funds out there, so if you take the time to do your research chances are high that you can find one that meets your needs. If you do not have the time or inclination to be heavily involved in the management of your portfolio or if you do not have the money to reach an optimal level of diversification on your own, mutual funds may be the solution you need.
Just remember that when you invest in a mutual fund you are giving up control of your money which leads to other risks such as the dangers of over diversification. You are also contributing money to the management of the mutual fund that will never be actively invested, making it impossible for there to be any returns on that portion of your investment. Once you weigh these pros and cons for yourself, you should be able to decide if mutual funds are right for you or not.