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Pros and Cons of Mutual Funds

What is a Mutual Fund?

A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors. The price of the mutual fund, also known as its net asset value is determined by the total value of the securities in the portfolio, divided by the number of the fund’s outstanding shares. This price fluctuates based on the value of the securities held by the portfolio at the end of each business day.

Pros of Mutual Funds

There are many reasons why investors choose to invest in mutual funds. Below are a list of Pros:

Convenience/Reliable Investment

Mutual funds are an easy way for the average investor to buy investments which would be too complex to manage on their own. It also is a very reliable investment that doesn’t have to be checked or stressed about, so it is great for people that don’t want to worry about or have the time to constantly check their investments.

Professional Portfolio Management

When you buy a mutual fund, you pay a management fee as part of your expense ratio, which is used to hire and pay professional mutual fund managers. This price is between 0.5% to 1.5% of the total Assets Under Management, but could sometimes be more.

Diversification/Risk Reduction

Mutual funds own numerous securities that span across various asset classes and industry sectors, which gives investors broad diversification. Some mutual funds own tens of stocks, others own hundreds, and some own over a thousand. Most mutual funds own between 50 to 200 different securities. Some funds specialize in owning stocks among one or two sectors, and others own stocks among multiple sectors.

Dividend Reinvestment

As dividends and other interest income sources are declared for the fund, it can be used to purchase additional shares in the mutual fund, therefore helping your investment grow. Typically, most mutual fund managers reinvest dividends, but if not, then they instead pay out dividends to investors.

Cons of Mutual Funds

Although there are many reasons why investors choose to invest in mutual funds, there are also reasons why investors choose to avoid investing in Mutual Funds. Below are a list of Cons:

Fees

Often Mutual Funds can be expensive to manage, and take a fee regardless of how well the fund did. For example, if the fund went up 15% one year, they would take their fee which wouldn’t be a big deal as you still made a good return on investment. But if the fund went down 15% for the year and they still took their fee’s you would have lost an extra 0.5% to 1.5% total value.

Taxes and Capital Gains

Like it or not, investors do not have a choice when it comes to capital gains payouts in mutual funds. Due to the turnover, redemptions, gains, and losses in security holdings throughout the year, investors typically receive distributions from the fund that are an uncontrollable tax event.

Don’t have access to trading or buying securities within the portfolio

You don’t have access to anything within the portfolio, as you would have access if you created and managed your own stock portfolio. For example, you can’t sell when a stock is high, or sell a stock and place the money into a different stock, because the mutual fund managers do all this for you and do what they think is right.

Share Price Calculation

Mutual fund share prices are only calculated and made public once per day so if you are the type of investor who likes to actively look at share prices, a mutual fund might not be the right investment for you, because they don’t post share prices very often.

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