Mutual funds: Investor pros and cons

Mutual funds are one of the most popular ways to invest. Trillions of dollars invested in mutual funds around the world, provided by well-known asset managers such as BlackRock, Vanguard and State Street Global Advisor. Mutual funds have many advantages, so they are by no means perfect, but it’s not surprising that a lot of money is invested in them.

There are key advantages and disadvantages of mutual funds, and whether they are the right kind of investment for you.

How mutual funds work

Mutual funds are a type of investment fund that allows investors to pool their money. Professional fund managers buy and sell securities in line with mutual fund goals. So instead of investing in many different companies, investors can simply buy stocks in mutual funds. All efforts to choose an investment are made behind the scenes by the fund manager.

• Mutual fund types: There are many different types of mutual funds available depending on what you want to invest in and even the time you want to invest in. For example, some funds invest in almost entire markets or parts of the market, such as the S&P 500 index and funds based on a particular industry. If you need money at a certain point in the future, such as a retirement, the Target Date Fund can provide solutions that can help reduce your risk.
• Mutual Fund Fees: Most mutual funds charge a cost ratio. This is the fee that covers the fund’s operating expenses (management fees, marketing, payroll) and provides profits to the fund manager. This fee is the percentage of total assets invested in the fund. Additionally, some funds have what is called sales load. This is a fee. Fortunately, many high-performance funds today do not charge loads, and it’s easier than ever to find them and avoid that unnecessary fee.

Due to the relatively easy investment in mutual funds, they are extremely popular, with many US companies offering mutual funds as part of their 401(k) plan. But should you invest in mutual funds? Let’s dig into their advantages and disadvantages.

Mutual fund professionals

Mutual funds have several advantages that have led to widespread popularity, including convenience, professional management and diversification. If you want to know how to choose the best mutual funds, look for them to hit all these points.

Attractive return

The best mutual funds can return 10-12% per year over time, while the best years can return more than 20%. Funding based on the S&P 500 is one of the best long-term performers.

Convenience

Mutual funds make investments easier. You can hold mutual funds in many different accounts, such as employer-sponsored retirement accounts, individual retirement accounts (IRAs), or securities accounts. All you have to do is order the number of shares you want to buy.

This process can usually be automated, and you can purchase a set of stocks on a regular schedule every two weeks. To make things even easier, employer-sponsored retirement plans are funded with pay deductions, causing your retirement account to disappear outside your sight.

Low price

The cost ratio for some top mutual funds is only 0.03 or 0.04% of investment assets per year. This would cost just $3 or $4 for every $10,000 you invested. It’s very cheap and works a lot of that money for you. Low-cost funds are usually passively managed index funds rather than actively managed funds.

Some mutual funds come without an expense ratio. Fidelity Investments is the Fidelity Zero Large Cap Index Fund (FNILX), offering a small number of unpaid funds and a S&P 500 clone (without calling it).

Mutual funds can be low cost, but many of them have high fees, so step on carefully.

Built-in diversification

Mutual funds have built-in diversification, which creates unstable investments. They invest in many companies and significantly reduce the impact of one company being poorly or failing. Therefore, they can have strong performance without excessive risk.

Some of the largest mutual funds are index funds, including the Fidelity 500 Index Fund (FXAIX), the Vanguard 500 Index Fund (VFIAX), and the Vanguard Total Stock Market Index Fund (VTSAX). These funds aim to track index performance, such as the S&P 500, which includes hundreds of top American companies, and offer a lot of diversification.

Professional management

When investing in mutual funds, you don’t have to worry about constantly buying and selling securities. Instead, the fund manager will do all the work for you. Automating your investment strategy means you have little time to spend managing your portfolio.

Passive investment strategies such as index funds allow the fund to track specific indices such as the S&P 500 and Nasdaq Composite. In contrast, active investment strategies use investment analysts to try to find stocks that are better than the benchmark index. Passive strategies tend to be better than aggressive strategies. This is because of low cost.

Dividend reinvestment

Another advantage of mutual funds is that they can automatically reinvest cash dividends. For example, if a mutual fund pays dividends or capital gains, the money can usually be reinvested at no charge.

Cons of mutual funds

Mutual funds have many advantages, but also some important drawbacks.

High price

Commissions on mutual funds have dropped significantly over the past decade, but in some cases the commissions can still be overloaded. Some mutual funds have a cost ratio of over 1%. That may not sound like a big percentage, but investors can spend tens or hundreds of thousands of dollars in their lifetime.

Additionally, brokers may charge sales loads to buy and sell funds, and some fund companies will hit you with fees that could be 1-2% of your total investment. Using the best broker for mutual funds, you can buy and sell your funds without any fees.

Conversely, there are many index funds available at low or no charges, allowing investors to build portfolios with some funds at low cost.

Out of control tax events

Investors don’t have to worry about buying and selling securities whenever they invest in mutual funds. That usually means that much less work is required from the average investor. However, if a mutual fund sells securities from a portfolio, it could lead to year-end distributions to investors, and these distributions are taxable investment returns.

These distributions are taxed either at a regular income rate or at a capital gain rate, depending on the duration of the fund’s investment. This means that a higher than expected tax bill may be left at the end of the year. People in high tax states may want to pay special attention to this issue as they can eat your profits.

There are no daytime transactions

Unlike funds (ETFs) traded on stocks and exchanges, mutual funds trade only once a day after the market closes at 4pm in the eastern part. This is not a major issue for passive investors, but it could mean that there are order prices that are different from those expected to be ordered manually.

Mutual Fund FAQ

Conclusion

The best mutual funds allow individuals to invest in professionally managed investment portfolios with built-in diversification. This is especially useful as investors don’t have to worry about buying and selling securities. However, mutual funds have quirks, such as high prices and sales committees, and can only trade once a day. However, you can mitigate the worst of these issues by carefully selecting mutual funds and looking for low-cost options.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. Furthermore, investors recommend that past investment products performance is not a guarantee of future price increases.