Are Mutual Funds Right for You?

Many Investors are unsure of investing in Mutual Funds. There are so many different Funds out there it can take a good deal of research.

A mutual fund is simply, a collection of bonds and/or stocks.  Through the fund, individual investors join together as a group to invest their money in stocks, bonds and securities.  By pooling their money investors gain greater buying power. Each investor owns shares, which are a portion of the fund’s total holdings.  The fund is professionally managed by a Fund Manager, whose investing track record is documented.

With a Mutual Fund you can make money in three different ways:

1) You can earn income from the interest on bonds and the dividends on stocks. The fund typically pays out almost all of the income it gains over the year in distributions to the fund owners.

2) The Fund Manager can sell securities that have increased in value to earn capitol gains. Most funds also distribute these gains to their investors.

3) The Fund Manager can choose not to sell holdings that have increased in value, the advantage being that the fund’s shares increase in value. Investors can then sell the higher valued shares for a profit.

Mutual Funds – Advantages

Fund Managers-Having professional management of your money is a key advantage.  Most investors do not have the knowledge or time to properly manage their own portfolio. Investing in a mutual fund is a great way for small investors to gain the services of a full time fund manager to monitor and tweak the fund’s investments.

Lower Risk- Owning mutual fund shares helps spread out the investors risk.  Funds are diversified by investing in a large number of assets, typically hundreds of stocks across many different sectors.  A loss in any particular investment is thus minimized by gains in others.

Group Power- Mutual funds buy and sell huge blocks of securities at a time. This lowers the transaction cost greatly over what an individual investor would have to pay on their own.

Liquidity- Your mutual fund shares can be converted into cash at any time upon your request.

Not Complicated- Just about every bank has its own selection of mutual funds offerings for a small minimum investment.  You can also set up automatic purchase plans to invest as little as $100 per month.

Mutual Funds – Disadvantages

Fund Managers- Investors hope that the professional manager is better at choosing stocks than they are. Managers are not infallible, nor do they have a crystal ball to guide them. So even if the fund loses money, the manager still gets paid.

Fees – Running a mutual fund is not inexpensive.  Expenses ranging from the manager’s salary to investors statements cost money and are passed on to the investors.  When comparing various mutual funds pay close attention to the wide range of fees from fund to fund. High fees can have negative long-term effects on your investment profits.

Dilution – Can occur when a successful fund becomes too large and ends up too diversified so that high returns from a few investments can’t properly offset the losses from the other investments. Successful funds often have investor money flooding in faster than the manager can find strong investments for the cash.

IRS – When the fund sells a security, a capital-gains tax is triggered.  This can be a concern for many investors.  You can minimize taxes by investing tax-sensitive funds or by holding non-tax sensitive mutual funds in tax-deferred accounts like an IRA or a 401(k).

As with most investment strategies, investors need to do their homework to determine if mutual funds are right for them.  There are so many mutual funds to choose from that selecting the right one for you can often be overwhelming.  Remember to pay close attention and compare the various fee structures the different funds charge. Also, using one of the many fund-screening tools available will help you pick a mutual fund that fits into your investment strategies.