Why Consider Investing In Mutual Funds?
Mutual funds are an extremely popular investment vehicle among individual investors, and do have a number of big advantages over going it alone. Like any investments, there are pluses and minuses to mutual funds, and the degree that one should invest in them depends to a large degree on one’s situation, preferences, resources, and goals.
Mutual funds pool the financial resources of many investors and offer the advantage of professional management as well as lower transactional costs. Bigger is better in some ways though and not as good in others, but overall, this is a great way to invest generally.
Large investors can hire dedicated managers of their portfolio, although one does need a large portfolio to make this cost effective, otherwise the management costs would be overwhelmingly high. So this is way out of reach of the average investor, but he or she may still want to benefit from having their assets managed by a money manager.
Since the assets of all the people who invest in a mutual fund is pooled, the totals add up to anywhere from very large to huge amounts, and the pooled assets can be managed by fund managers at not only acceptable costs, but very desirable ones on a percentage basis.
Another big advantage of mutual funds over individual investing is the fact that they can trade in an enormous number of things, hundreds or even thousands of issues, something that would not be even close to possible on your own. The billions of dollars in assets that funds hold simply give them much more buying power than individual investors could ever aspire to.
Simplifying The Equation
So scope and breadth becomes greatly enhanced, which leads to all the potential for all the diversity you could ever want. Diversity can definitely be an advantage, as it does spread out certain risks, although the degree of this depends on the makeup of the fund.
For instance, the world’s largest fund these days buys all the stocks on the S&P 500, so you own a piece of all 500 stocks when you buy this fund, and this is a huge fund, with net assets of almost $200 billion. So you don’t worry about a particular component having trouble, and people do see that as an advantage, and in some ways it is.
So with that much in assets, transaction costs are kept to a minimum per dollar held in it, and in fact passively managed funds like this have the lowest percentage of costs to value than anything you’ll ever see in the financial world.
These are called index funds and they just hold everything in an index in a given proportion, and there isn’t even any thinking involved in it, so they are very inexpensive to manage. They are set up to mirror the indexes they follow, which is very easy to do.
There is a feeling out there among many investors that you can’t beat the market so to speak long term, which actually depends on the size of the portfolio, and the smaller the portfolio, the easier this is to do, but it’s much more difficult with huge ones.
A Matter of Fit
Index funds aren’t the be all and end all of mutual fund investing though, and there are countless funds out there which don’t follow indexes, but follow other investment strategies, and the whole idea of all of this is to have funds that best match the strategies that investors have, which can differ a lot.
If someone has a very long term horizon though, and is looking to minimize their risk versus some other strategies that may be more specific to certain sectors or regions or whatever, then investing in index funds may indeed fit one’s investment preferences quite well indeed. Indexes are very well diversified and you basically ride the market wave, which over the long term has proven to be very reliable.
So time horizon is part of it, but some investors may prefer a more actively managed approach even though they may have a long term horizon, focusing more on what’s hot and what’s not, and trading more as well.
It’s all about balancing risk and return here, and this is where the preferences and goals of investors really come in, and the less diversified an investment is, the more risk there will be, but not necessarily much more risk.
The performance of actively managed funds come down to the skill of the fund managers, and the better ones will outperform the less skilled ones, but we do have ways to differentiate this, and the biggest thing people look at is the fund’s past performance.
Getting a fund or a selection of funds to best fit an investor is also very important. So we need to both be selecting good funds and also ones that fit the goals and risk tolerances of the investor.
People can and do select their own funds, but they do need to be careful with their selections, and often times these selections are done in consultation with an investment advisor, who will use their expertise to not only recommend the good ones, but to ensure that the selections are appropriate for the investor’s circumstances.
The 3 Main Classes of Mutual Funds
Due to the massive popularity of mutual funds generally, investors are faced with a myriad of choices of which ones to invest in, and this variety is not just among similar funds, it is also among different types with different investing strategies and objectives.
While people usually think of mutual funds as investing in equities, the stock market in other words, there are mutual funds for pretty much every type of investment. There are three main classes of mutual funds, growth funds, income funds, and money market funds.
Growth funds, which include equity funds, have their main goal as being capital appreciation, the stocks in it going up in value over time for instance. Income funds focus mostly on dividend payments, and are dominated by bonds, although other forms of investment that deliver their value primarily by income may be included.
Income funds have less potential for growth but are less risky than income funds. The type of fund with the least risk, as well as the least potential for growth, is money market funds. They invest in short term financial instruments which are far less volatile than other investments, such as treasury bills, but are much more stable as well and therefore produce more reliable and predictable returns.
Seeking The Right Balance
Mutual fund investments look to not only seek the desired amount of diversity in the fund itself, within a certain asset class, they also seek to strike the right balance between asset classes and types.
So someone may want a certain diversity in an equity fund, with a lot of different stocks in it, across several industry sectors. One may also want to invest in a bond fund which holds a wide diversity of bonds to spread the risk that way.
However, one of the biggest risks in mutual fund investing is market risk, where markets move together, and this happens in both directions, but it’s the downward direction that tends to concern investors, since the overwhelming majority of mutual funds are long the market, in other words betting on things going up not down.
Investors, and funds, may seek to have various amounts of their portfolios held in cash, not invested in other words, and may move more or less to cash as conditions dictate. This actually happens to a pretty large extent at times and is a big reason why these markets have so much market risk, because money gets moved out the market and is placed elsewhere in times of market uncertainty, which drives the value of the market down, and can do so considerably.
Investors will also use different strategies as far as the percentage of their assets held in the 3 major classes of funds, depending on the level of aggression sought.
Those with the least risk tolerance may hold all of their funds in a money market fund for instance, those with the most risk tolerance may hold everything in growth funds, and others may seek some sort of appropriate mix of the 3 to suit their needs.
Others may invest in hedge funds, which are primarily set up to balance off these risks, particularly market risk. Hedge funds tend to do better in general market downturns, and may hold short positions as well as investing in things like gold which do well in downturns as people invest more heavily in these things when the market goes sour so to speak.
One may hold these hedged investments when they are speculating that things may go down, or they may hold them simply to offset the risks of their position, and derivatives such as futures and options primarily serve as hedges, although all of these things can be speculated with as well, as is the case with just about any investment.
There are definitely some real advantages to investing on your own, and contrary to what a lot of people think, you can beat the market with these, you can beat the funds, and trading smaller and with less issues does allow one to enter and exit positions much more easily, due to the much smaller volume involved compared with funds.
So individual investing can be like a speed boat, compared to a large ocean going ship of funds, which take a long time to turn around, but if you’re going to operate a speed boat, you are going to have to be skilled in doing so, otherwise you may be better off with safer and more stable options with an experienced captain at the helm.
Mutual Funds FAQs
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How do you make money from a mutual fund?
Mutual funds sell shares in their funds which you purchase at a certain price per share. As the mutual fund increases in value from their underlying investments increasing in value the value of your shares rises. If you sell your shares at a higher price than what you paid for them, you get to pocket the difference.
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Can you lose your money in a mutual fund?
If you sell your shares in a mutual fund for less than what you paid for them, you realize a loss which equals the difference between what you paid and what you redeemed your shares for. A mutual fund’s investments fluctuate in value and this is not unlike buying and holding stocks which can go up and down in value quite a bit over time.
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Are mutual funds safe?
Any time you invest in a mutual fund, you are taking on the full risk that the fund may depreciate in value over the time that you hold shares in it. The safety of a given mutual fund depends on the safety of its investments, with stocks being the riskiest, followed by bonds, and with money market funds representing the lowest risk.
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Which is best mutual fund to invest?
Seeking out the best mutual fund starts with determining what your investment objectives are and how much risk you are comfortable taking on. As a rule, mutual funds that have the greatest potential for gains also come with the most risk. Once this is determined, you then look at competing funds to decide which look the most promising and reliable.
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What is Blue Chip Fund?
Blue chip stocks are stocks issued by companies that have shown greater stability over time and are also very liquid, which have proven to be popular over the years with investors. A blue- chip fund concentrates on these stocks although these stocks are generally fully subject to market risk and therefore still require an adequate amount of attention.
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How do I choose mutual funds?
Historically, people would buy mutual funds from advisors, who actually are more like sales people for the institution that they work for but will at least provide some advice and expertise over and above the little amount that most investors possess. You can now buy them directly from the fund although this does require some knowledge of what you are doing.
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Which company is best for mutual fund?
There are a number of successful mutual fund companies out there, such as BlackRock, Fidelity, Vanguard, State Street, Charles Schwab, and JP Morgan, among others. The results of their funds can vary though and it’s best to look at who does best in the category of funds that you are looking to purchase.
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How do I open a mutual fund account?
Mutual fund accounts can be opened face to face with a mutual fund dealer, over the telephone, or these days, even online. The first step is to register an account with a mutual fund dealer or with the fund company. You then choose the fund or funds you wish to invest in and then place an order to buy shares in one and make arrangements for payment.
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Which mutual fund is best for SIP?
The desirability of a mutual fund and the strategy of a systematic investment plan or SIP are independent of each other. You want to select mutual funds according to their desirability, with a SIP acting as a strategy of purchasing shares in the fund in a systematic way by investing fixed amounts at regular intervals.
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How do I invest in mutual funds?
The first step is to learn the basics of mutual funds so that you have some idea about what you are doing. You then define the objectives of your investment, decide how much risk that you want to take on, and then and only then research the various funds that may fit your needs. You then select one or more to invest in and purchase shares in them.
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Is mutual fund income taxable?
Mutual funds, like just all investment income, is taxable income. You pay taxes on gains from mutual funds two ways, by paying taxes on distributions while you hold shares in a fund, and on any gains that you realize when you cash them in. Mutual funds pay out annually so this reduces the tax burden at redemption, but has the disadvantage of paying tax up front.
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What is in a mutual fund?
A mutual fund is a pool of money contributed to by many investors to be used to invest in various types and mixes of securities and seek gains for the investors in the fund. This has real advantages over investing yourself as it allows for investors to obtain much more diversified positions than they could otherwise achieve on their own.
References & Scholarly Articles for Mutual Funds
Books on Mutual Funds
- Mutual funds for dummies (Authors: Eric Tyson, Originally published: June 9, 1998)
- Mutual Fund Industry Handbook: A Comprehensive Guide for Investment Professionals (Author: Lee Gremillion, Originally published: 2005)
- Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor (Author: John C. Bogle, Originally published: 1999)
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