Mutual funds have advantages and many disadvantages. It is very important to be aware of both the pros and cons of mutual funds before investing in them.
Advantages of Mutual Funds:
Mutual fundsdo have the advantage of diversifying an investor’s portfolio. Diversification is investing in the stocks of a variety of companies. This serves to lower an investor’s overall risk. Most investors are familiar with the term: “Don’t put all of your eggs in one basket.”
Diversification is important when investing. It is not a good idea to have most of your monies invested in just one or two company’s stocks in the same industry. For instance, you wouldn’t want to own all the technology companies in your portfolio. If the tech industry took a downturn, so would your overall portfolio returns!
An investor should also be careful of being fully invested in the company’s stock that they work for. For instance, you would have much to lose if you were laid off or the company went out of business. A prime example of this is the Enron corporate scandal. The company went bankrupt and thousands of employees not only lost their jobs but also their retirement monies!
Some individual investors feel it is to their advantage to turn over their money to “professional” mutual fund managers. These individuals feel they don’t have the time to educate themselves or the time to research stocks. Hence, they find mutual funds convenient and appealing. However, in choosing mutual funds, many individuals are settling for “lower” overall returns on their portfolios!
Disadvantages of Mutual Funds:
Unfortunately, mutual funds have numerous disadvantages! One huge disadvantage of mutual funds is that they have “hidden” fees that can diminish your returns. These hidden costs can put a big dent in your returns, especially over the long-term! Unfortunately, there are individuals unaware that they are even being charged fees. Some people believe they are not being charged anything in their mutual fund accounts!
There are many different types of fees a mutual fund company can charge the investor. It is very important to compare mutual fund companies to know what fees they charge! These fees reduce an investor’s overall returns!
I’ll start with the 12b-1 fees. Most financial experts recommend avoiding mutual funds that charge these fees! The 12b-1 fees are annual marketing fees on a mutual fund. An investor should not have to pay for companies advertising expenses!
Should an investor decide to purchase an “index” mutual fund they should seek a company, such as Vanguard. Vanguard has a low expense ratio and offers “no-load” funds. This company offers low-cost index mutual funds and ETF’s. Vanguards costs are lower than the industry average.
It is also important to know if the mutual fund you own is a “load” fund or a “no-load” fund. A “load” fund is a mutual fund that charges the investor a sales charge. A “front-end load is charged when buying shares and a “back-end” load is charged upon the sale of your mutual fund shares. The mutual fund company determines the amount of the charge. A “no-load” fund, on the other hand, does not charge mutual fund investors a sales charges or commissions!
Another disadvantage is that mutual fund managers tend to trade too much in their efforts to try to beat the market. The author, Ramit Sethi writes: “Mutual funds “turn over” stocks frequently, meaning they buy and sell funds a lot (incurring trading fees) and, if held outside a tax-advantaged account, taxes for you!” Not a good deal!
Many Mutual Fund Managers Underperform The S&P 500 Index:
One other “huge” disadvantage is that statistics reveal that many mutual fund managers have a very “poor” record of beating the S&P 500 index! Studies have shown that over a five year period the majority of mutual funds perform worse than index funds!
A big percentage of large-cap mutual fund managers underperform the S&P500 Index Fund year after year! Investorsshould track their annual percentage gains in their mutual funds against those of the S&P 500 Index fund.
Unfortunately, many employees 401K’s consist of a spread of mutual funds. Preferably, an employee would like to see the S&P 500 Index fund in their 401K plan! It is also the employee’s responsibility to monitor what their company’s 401K consists of!
In conclusion, one should “weigh” both the advantages and disadvantages of mutual fundsbefore investing in them! Keep in mind one big disadvantage is that the majority of mutual funds “underperform” the market! Investors should also be aware of the fees the mutual fund is charging them! Vanguard charges low fees for their index mutual funds. Moreover, investors need to keep in mind the tax liability they will incur with the constant trading that mutual fund managers do.
I, personally, am not an advocate of mutual funds! Why? Because a large percentage of mutual fund managers lose to the market! It has been documented that mutual fund managers fail to beat the market’s returns 75% of the time!
As a “D-I-Y” investor, I prefer to pick my “own” companies to invest in afterextensive studying! Using my stocks skills, I earn much higher returns, than mutual fund managers, by selecting my “own” stocks to invest in. This saves me money on fees and allows me to make my own investment decisions! Investing in mutual funds would only serve to lower my overall investment returns! I use the discount brokerage firm, Robin Hood, which does not charge any fees, to buy and sell stocks! I see no need for a full-service brokerage firm. All the investment tools I need are online.
