You cannot be too careful while investing in Mutual funds!
Introduction
In the last blog on mutual funds, we got familiar with the basic understanding of what a mutual fund is, how the terms associated with the concept- such as securities and portfolios work, the different types of mutual funds, how can you gain good returns on mutual funds and so on...
But all this information is undermined if we do not introspect on the fact that a mutual fund –which is a major type of Investment – can or cannot be beneficial for the investors, whether they are new to investing or are accomplished investors.
Everybody invests in some or the other type of investment in the hopes of getting a return on what they invest in, a little if not much. But what are the difficulties that we as investors might face while engaging with our money managers to invest in mutual funds on our behalf? And do we pay heed to the fact that there might be some problems with investing in mutual funds which might not be obvious to new investors?
By the end of this blog, you will be able to fully comprehend if you can be careful enough while thinking of investing in mutual funds, especially if you are a new investor. Stay tuned with BankQuality to read more on the latest financial happenings around the globe!
Let us begin by understanding the benefits and detriments of investing in a mutual fund.
Advantages of Investing in a Mutual Fund
In today’s financial scenario, Mutual funds are currently the most popular investment vehicles (a financial instrument through which investors aim at gaining positive returns) for the majority of the investors. It’s not surprising that Mutual funds are the most favored investment choice in the United States. There are many reasons why investors choose to invest in mutual funds over any other type of investment with such a high frequency. Hence it is extremely important to know the reasons that drive a lot of Investors crazy about investing in mutual funds.
1) Mutual funds provide for an advanced Portfolio management – So when a small-time investor or any other investor invests in a mutual fund, you and they have to pay a portion of money as the Asset management fee which is a part of the Expense Ratio (ER) - which is a tool that measures how much of a fund’s assets are used for administrative and other operating expenses - is used to hire a professional money manager who will buy and sell stocks, bonds, etc.
Thus, an asset management fee becomes an advantage by being a small price you pay for getting professional help in the management of your investment portfolio which in turn would increase the chances of you making a higher rate on returns.
2) Risk reduction – As the name itself suggests, reduced portfolio risk can be achieved by a very interesting feature of mutual funds, which is known as Diversification, as mutual funds can invest anywhere from 50 to as much as 200 securities under one investment portfolio, well, which also depends on the focus of the investment. There are many stock index mutual funds that own more than 1000 individual stock positions.
3) Convenience and fair pricing - Mutual funds are very simple and easy to understand. Even for a new Investor! There is no particular limit or bound set on a particular figure (amount of money) that an investor can invest with a mutual fund. They typically have a very low investment (as low as $2,500) and are traded only once a day at the closing Net Asset Value (NAV). This low investment helps in eliminating the price fluctuations that the market faces throughout the day and also the various arbitrage practices that the day traders indulge in.
4) Dividend Reinvestment - Mutual funds also declare for themselves, dividends and other interest incomes which can be further used to purchase additional shares of the same mutual fund, hence helping your investment grow.
Now that we have looked at the various advantages of being an investor in mutual funds, we need to also shift our focus to know that many disadvantages come with being an investor in a mutual fund. These disadvantages are as follows:
Disadvantages of being an investor in Mutual Funds
1) High expense ratios and sale charges – As already mentioned before, if you don’t pay attention to the expense ratios which are to be incurred in the mutual funds, things may get out of hand, and you may end up losing your investment, let alone get any rate of returns. There are specific considerations to make while investing in mutual funds, that you should be careful while investing in funds that have an expense ratio higher than 1.20% as they become very costly to bear. Also, one should be alert in investing with mutual fund companies that have no sale charges and advertising fees in general.
2) Sub-optimal Purchases – While investing in a mutual fund, a new investor might not be privy to the fact that money managers cannot hoard cash. When you buy shares of the MF, the money manager must, in turn, buy shares of stocks that fit within the guidelines of the prospectus of the portfolio. For example, If you have invested in a ‘small value fund’, the manager cannot buy a ‘large growth’ stock even if he justifies it as a better buying opportunity.
3) Forced redemption - One of the most disappointing features of mutual funds is that the money managers are forced to sell stocks if the investors decide to sell the shares of their mutual fund. This happens because the fund is not left with enough cash reserve to meet the demands since the rush of redemptions happen only when the market faces a sharp decline.
4) Over Diversification – Lastly, by a consequence of the sub-optimal purchases by money managers, mutual funds have to suffer from over-diversification, which simply means that the MF has so much cash that it is forced to own hundreds of stocks within its classification. And as a result, the Money Manager cannot focus on potential stocks and the MF becomes a closet Index fund.
Conclusion
So, now you know that investing in Mutual funds for a novice investor isn’t as easy as it sounds, but BankQuality gives new investors like you to remain informed a make a proper choice before spending your money and thus making sure you invest in the right place. Click here to learn more from the experience of other investors by reading reviews on our website TODAY!