Identifying the advantages and disadvantages of mutual funds allows the investors to make informed investment decisions. Mutual funds provide an opportunity for individual or small-scale investors to access a diversified portfolio. Due to this reason, mutual funds are considered one of the most popular investment vehicles in the current investment market. However, just as with every investment method, both advantages and disadvantages of mutual funds can be identified.
There are many investment options that can be seen in the modern investment market. Existing investors as well as the new investors who enter the investment market should have the basic knowledge of the funds that have the capability to give the best returns for their investments. This makes it crucial to identify the advantages and disadvantages of mutual funds as well as other investment options in order to compare and invest in the best available option.
Advantages of Mutual Funds
– Access to a diversified investment portfolio
When investing in a mutual fund, the investor gets the opportunity to access a diversified investment portfolio. Since mutual funds consist of at least a hundred various investment options, the fund managers get the ability to invest the investors’ funds in various investment instruments based on profitability. This helps to reduce the risk of investing as the investment is spread out through various asset classes.
– Affordability
Mutual funds allow the investors to purchase in smaller denominations from $100 to $1000 minimums. This provides an opportunity for small-scale investors or individual investors to enter into the investment market and try for profit gains. Apart from that, mutual funds allow investors to make periodic investments through regular monthly purchase plans. It encourages small-scale investors to enter the market.
-Reduced risk
Compared to many other available investment instruments, the risk of investing in mutual funds is relatively low. Since the investments are spread over multiple asset classes, the possibility of gaining a total loss is comparatively lower than other investment options.
– Advanced portfolio management
Mutual funds are usually managed by well-experienced fund managers who have diversified knowledge of all the available investment instruments in the market. They often have the ability to predict the profitability of each investment instrument based on economic behavior. They use this knowledge in investing investors’ funds in the best available options for maximum returns. The investors pay management fees as a part of the expenses ratio, for the fund managers for their service.
Disadvantages of Mutual Funds
– Lack of control
Since the funds are usually handled by the fund managers, they only decide on which funds the investments should be done. The investors have a very low level of control over selecting the asset types to invest in. This can be disadvantageous as the investor expectation and the fund manager’s expectation by the investment may differ.
– Fees
Mutual funds usually carry fees that will reduce the return of the investment. These fees are usually sales charges, annual charges, management charges, annual fees, and penalties for early withdrawal of funds.
– Possible management abuses
Since the investors do not have much control over the investment options, it gives more opportunity for the fund managers to abuse their authority. Turnover, churning and window dressing are the most common ways of abusing management power. Excessive replacement, unnecessary trading, and selling the losers prior to quarter-end in order to fix the books are ways of abusing management power.
– Dilution
While investing in mutual funds can reduce the risk of the investment, it can also dilute the profits of the investments. It is important not to invest in multiple mutual funds at the same time.
The above-mentioned advantages and disadvantages of mutual funds can be useful for any investor in making investment decisions.