Mutual funds are one of the primary investment options that many use today. These funds are investments that are professionally managed and combined a variety of products together to create one investment option. Stocks, bonds, currencies, gold, and even real estate can all be owned through mutual funds. They must be SEC registers and all mutual fund managers must be a registered investment advisor.
By evaluating all of the mutual funds pros and cons, each investor can decide if this is the right thing to add to their portfolio. Here are advantages and disadvantages to consider.
The Pros of Mutual Funds
1. Mutual funds are an incredibly convenient investment tool.
Most investors don’t have the time, energy, or knowledge to invest into each component that makes up a mutual fund. It requires a lot of due diligence that just can’t be done outside the 9-5 grind. Mutual funds make it a lot easier for the average investor to get the best options for their portfolio with a single trade and they don’t even need to worry about managing the fund. They just let the RIA manage it so it can obtain growth.
2. It’s one of the easiest ways to achieve real diversification.
Many investors think of diversification as having a handful of different investment options in their portfolio. Mutual funds create a ridiculous amount of diversification in comparison, providing sometimes 1,000+ different securities over every asset class or industry sector that is available. This gives the average investor a good chance to protect their cash without having to worry about what the market index might be doing.
3. Every mutual fund is professionally managed.
Each mutual fund that is offered to investors has a stated investment objective that must be followed by its manager. The actions of the manager in relation to those stated objectives receive consistent oversight from the federal government. This limits the amount of fraud that can occur through the fund, adding yet another level of security to the investment process.
4. Virtually anyone can invest into mutual funds.
It doesn’t require a lot of money to get started with a mutual fund investment. This makes it a suitable option for virtually every portfolio, even if there is only a few thousand dollars available for investing. With many households struggling to save enough for retirement, this investment option could help money to grow consistently and quickly so that long-term financial goals can finally be achieved.
5. Mutual funds can be owned inside of retirement accounts.
Although there are some tax complications to a mutual fund investment, these issues can be reduced if investments are made through a 401k or a traditional IRA. Taxes aren’t paid on contributions until withdrawals are made. If those withdrawals happen once the holder of the account reaches the correct age, the taxes are paid as ordinary income instead of capital gains. Roth IRAs come after taxes are paid on income, which means withdrawals in retirement are tax free, completely eliminating any taxation issues whatsoever from mutual fund distributions.
6. Sector mutual funds allow for some “gambling” when it comes to an investment.
Sector mutual funds don’t focus on a well-rounded portfolio of all industries and assets. They instead stick to one industry sector to give investors the chance to go all-in on specific actions they think will happen. Many Baby Boomers are either retired or are getting ready to retire right now. They’ll have expanded medical costs after retirement. A sector investment into health care could provide an amazing return that other “general” mutual funds wouldn’t be able to match.
7. Liquidity is always an option.
If an investor needs some cash for whatever reason, there isn’t a waiting period or a penalty that occurs should they sell. There may be broker fees or administrative costs, but there would be the 10% taxation penalty above all other taxes or penalty fees to pay for an early withdrawal.
The Cons of Mutual Funds
1. Mutual funds may come with a heavy number of fees.
It is rather expensive to manage a mutual fund because of the trades that are involved, which means investors are charged loads, commissions, and annual fees no matter how well the fund as performed. Investors are able to minimize some of these fees by going around a broker to purchase directly from a fund family, but not every beginning investor knows how to do this. The more actively managed a mutual fund happens to be, then the more likely that high fees and costs will be passed along to the investor.
2. Share prices are only made available once per day.
Mutual funds are not updated like stocks and other investment tools. The share price for every mutual fund is only calculated and publicized once per day, making it impossible for investors to take advantage of market movements. The price sheets of each mutual fund is dependent on the net asset value, so investors won’t know what their price will be until the market day ends.
3. Capital gains must always be distributed.
The biggest issue that investors face with mutual funds are the capital gains that they receive. These gains must be distributed to all shareholders, no matter how long an investor has been involved with the mutual fund. This means many investors are taxed at the high short-term capital gains rates instead of the low long-term capital gains tax rates that come with other investments.
4. Taxes can be paid even when money is lost on a mutual fund.
Sometimes a mutual fund will need to raise some cash will sell profitable investments. This creates a capital gain for investors because all gains must be distributed, even if the mutual fund has been performing rather poorly. What this means is that an investor may owe taxes on the gain that was distributed even though they’ve lost money on the investment overall.
5. There are different types of shares that all offer different types of fee and investment structures.
Most investors prefer to use what are called “B” shares because the load charges come out on the sale instead of the purchase of mutual fund shares. “A” shares occur upon purchase and could require up to 8% of the total purchase price as a fee. There are “C” shares, “D” shares, and “T” shares that all have specific charges and fees. They are outlined in the prospectus that is received, but a beginning investor may not have a clue as to what any of that information means.
Mutual Funds Make a Lot of Sense As An Investment for Most Households.
They are an especially beneficial option for retirement accounts. By weighing all of the mutual fund pros and cons, every investor can decide if this is the best option for their money.