Ever wished that you could buy a number of different assets by making a single investment? That is the inherent selling point of a mutual fund, which packages a number of assets and sells them through one security. Read on to learn more about this popular investment vehicle and whether mutual funds are the right investment for you.
Don't Miss Our Christmas Offers:
- Discover the latest stocks recommended by top Wall Street analysts, all in one place with Analyst Top Stocks
- Make smarter investments with weekly expert stock picks from the Smart Investor Newsletter
What is a Mutual Fund?
A mutual fund is a type of investment in which investor monies are pooled together to buy an assortment of assets. The portfolio is divvied up into individual shares, which are available for purchase.
The specific focus of every mutual fund is defined by a prospectus, which is filed with the U.S. Securities and Exchange Commission (SEC). This prospectus details the particular fund’s objectives and investment strategy. Some mutual funds might try to mimic the performance of an index (these are known as Index Funds), while others may focus on specific sectors or types of businesses (such as growth stocks or value stocks).
Mutual funds are actively managed, meaning that there is a financial professional monitoring the fund’s performance and making adjustments as needed.
What are the Advantages of Investing in a Mutual Fund?
There are a number of advantages of investing in a mutual fund. These include:
Instant diversification: Among the benefits of mutual funds, the ability to instantly diversify your holdings is at the top of the list. In other words, as soon as you have bought into a mutual fund, your portfolio will be comprised of multiple investments, spreading your risk out among different assets.
Professional management: Another key advantage is the ability to place your monies in the hands of a professional money manager. Even if you enjoy following the stock market and reading the financial papers, a professional manager has both the experience and additional tools at her or his disposal that can give them a leg-up when it comes to making investment decisions.
Economies of scale: There are a number of different investors who will have placed their money in your mutual fund of choice, creating economies of scale that are simply not accessible for individual investors. These could be certain stocks, bonds, or holdings that you would neither be able to afford nor have access to.
Liquidity: Mutual funds are traded once a day after markets close. This closing price is known as the fund’s Net Asset Value (NAV), which is the per-share value of the mutual fund’s assets minus its liabilities. You can either buy or sell shares in mutual funds through a broker or directly via the fund itself. Government regulations require mutual funds to keep no more than 15% of their assets in illiquid holdings (defined as an investment that cannot be reasonably sold within seven days without upsetting market conditions). This allows mutual fund investors the certainty of knowing that they can always cash-out their holdings if their needs or priorities change.
What are the Disadvantages of Mutual Funds?
While there are some marked advantages of mutual funds, there are a number of drawbacks as well.
Costs and management: Mutual funds must pay for the active management of investor money. These fees vary by fund, but serve as an extra cost that investors are on the hook for. Not all funds are managed equally well, and some funds have not shown an ability to consistently outperform benchmark indices.
It is always a wise decision to review the past performance of mutual funds you are considering investing in. While past is not necessarily prologue, it can give you a strong indication of whether the manager can be trusted with your monies.
Outsourcing decisions: When you place your money in a mutual fund, you are essentially ceding control of your investment decisions for this particular pot of money. Hopefully, you have placed your money in good hands, but it also means that you will have to trust someone else with your finances.
How Can I Decide Which Mutual Fund to Invest In?
There are a number of different types of mutual funds, ranging from ones seeking more aggressive returns to those with a more conservative approach.
As a first step, it is important to define your investment goals. Those with a higher tolerance for risk would do well to look for mutual funds more heavily invested in small-cap or growth companies. It follows that those seeking more certainty would prefer mutual funds that focus on larger, dividend-paying companies or those purchasing government bonds.
Once you have a sense of the type of returns you are looking for (and the requisite risk you are prepared to stomach), research past performance of both the mutual fund and its management. This can give you a strong indication if this is a good place to park your monies.
TipRanks’ tools and datasets can allow you to review the historical performance of a number of different mutual funds, while gaining insights into their assets and liabilities.
In addition, using TipRanks’ tools will allow you to review news stories about stocks in the fund’s portfolio and whether analysts expect its growth to outpace the market, among other metrics.
As part of your research, also make sure to understand the fee structure of the mutual fund. To prevent falling victim to fraud, confirm that the fund has filed a prospectus with the SEC to ensure that it is complying with all laws and regulations.
Conclusion: The Mutual Benefits of Mutual Funds
Mutual funds hold the promise of instant diversification. Along with having access to assets that would otherwise be out of reach, your management fees are paying for the expertise of these money managers.
Mutual funds are popular among investors because they offer a relatively secure pathway to achieve steady growth. As such, they can form an important part of your investment strategy for both near- and long-term goals. Mutual funds can be a good fit for many individual portfolios, especially for those looking diversify their holdings without constantly keeping updated on market trends and developments.
When they grow in value, the wealth of all those invested in the fund investors will rise accordingly, providing mutual benefits for all.
Learn money management, and use data-driven stock insights with TipRanks.
