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A mutual fund is a collective investment vehicle that pools money from different investors in form of securities like stock and bonds. Investors purchase shares of a mutual fund and increase their buying power as well as diversify their holdings.
The mutual funds have devoted fund managers who manage the portfolios of the investors and ensure they receive capital gains or dividends from the returns of purchased stocks. Let’s look at the pros and cons of investing in a mutual fund.
Pros:
1. Convenience: Mutual funds is suitable for investors who don’t have time to micromanage their portfolios. They’re easy to buy and give investors an opportunity to add a number of securities to their portfolio at lower prices compared to when investing on their own.
2. Expert management: Investors pay professional managers who help them in making the right investment decision and receive the best risk-return trade-off based on their objectives.
3. Diversified risks: Mutual funds have diversified risks since the purchased stocks have risks spread across several investors. The more diverse the fund, the fewer risks it carries.
4. Liquidity: Mutual funds are not affected by the liquidation of stocks. In an event of a sale of shares, the shares are liquidated at the end of the day.
5. Reinvestment of income: Mutual funds allows you to re-invest the dividends and interests in additional shares. This gives you a chance to grow your portfolio without paying additional fees.
6. Affordable: You can buy a host of inexpensive and expensive shares or securities through mutual funds. You can own shares in Google NASDAQ: GOOG for as little as $50 per month.
7. A range of investment options: There is a wide range of investment options and objectives for the risk averse investors and middle-of-the-road investors. E.g. buy-hold-philosophy investment.
8. Systematic investment plan and withdrawal: Money is invested directly into the stock fund from the investor’s bank account or withdrawn from the stock account into a bank account without any transaction fee.
9. Flexible: You don’t need a lot of money or experience to invest in mutual funds, you can invest small or with large amounts of money.
10. Factor exposure: When buying funds, investors can focus on growth, value and low volatility factors for a great investment decision.
Cons:
1. Fees: The funds’ fee is high especially on actively managed funds. Some funds can attract 2% of the annual fee on front-end, back-end load and 12B-1 sales charges.
2. Poor trade execution: You can’t open or close the mutual funds during a trading day. You can only acquire or get out of a mutual fund at the end of a trading day.
3. Tax inefficiency: Investors have no choice in capital gains payouts from mutual funds. High turnover, redemptions, gains, and losses in securities may result in capital gain distribution and uncontrollable tax events.
4. No control over portfolio: Once you invest in mutual funds, you give the control of your portfolio to fund managers who run it.
5. Capital gains: You’re taxed based on funds distributed gains from selling individual holdings or sometimes when you haven’t sold any shares. If your funds have high turnover, it results in an annual distribution of capital gains.
6. Over-diversification: Holding more securities may negate your reasons for market exposure since you’re less likely to experience their individual returns on your portfolio.
7. Cash drag: Mutual funds maintain assets in cash in order to maintain the liquidity purchases and to satisfy the investor’s redemptions. Investors will be required to pay for the funds to remain in cash thus increasing investors liquidity cost by 0.83%.
8. High expense ratio: You should be careful when investing in funds with an expense ratio of above 1.2% as they can get out of hand and cost you more.
9. Management abuse: Funds manager may abuse his authority through unnecessary trading or other market abuses which may affect your investment.
10. Share price calculations: Share prices on mutual funds are calculated once per day and made public. The share price depends on net asset per value of the securities and is set at the end of market day.
