A mutual fund is actually formed as an investment company and manages stocks, bonds, real estate investment trusts or REIT’s and possibly a collection of other securities for the benefit of the shareholders. Mutual fund are a pooled security, this means a large group of people “pool” their money together to form the fund.
Investing in a share of a mutual fund is different from investing in shares of stock. Unlike stock, mutual fund shares do not give its holders voting rights. Voting rights are the ability to vote for or against how the company does it’s business. A share of a mutual fund represents investments in many different stocks (or other securities) instead of just one holding.
Investors typically earn a return from a mutual fund in three ways:
- Income may be earned from dividends on stocks and interest on bonds held in the fund’s portfolio and are paid out annually as distributions. Shareholders may choose to receive a check for distributions or to reinvest the earnings and get more shares.
- If the fund sells securities that have increased in price, the fund makes a capital gain. Most funds also pass on these gains to investors in a distribution.
- If fund holdings increase in price but are not sold by the fund manager, the fund’s shares increase in price. You can then sell your mutual fund shares for a profit in the market.
Mutual funds have advantages as well as drawbacks. Here is an overview:
Advantages of Mutual Funds
- Professional Management – The primary advantage of funds is not having to pick stocks and manage investments. A manager or set of managers in a team make the decisions of what securities to buy, sell and hold using research and skillful trading. Investors purchase funds because they often do not have the time or the expertise to manage their own portfolios, or they don’t have access to the same kind of information that a professional fund has. A mutual fund is a relatively inexpensive way for a small investor to get a full-time manager to make and monitor investments.
- Diversification – By owning shares in a mutual fund instead of owning individual stocks or bonds, your risk is spread out across many different holdings. By diversifying, you spread investments across a large number of assets or asset classes so that a loss in any particular investment is minimized by gains in others. Large mutual funds typically own hundreds of different stocks in many different industries. Generally its’s impossible for an investor to build this kind of a portfolio with a small amount of money.
- Variety – Mutual funds today exist with any number of various asset classes or strategies. Some mutual funds are even structured to profit from a falling market. Mutual funds provide opportunities for foreign and domestic investment that may not otherwise be directly accessible to ordinary investors.
- Transparency – Mutual funds are subject to industry regulation that ensures accountability and fairness to investors.
Disadvantages of Mutual Funds
- Costs and Fees – Creating, distributing, and running a mutual fund can be an expensive undertaking. Since fees vary widely from fund to fund, failing to pay attention to the fees can have negative long-term consequences. Actively managed funds incur transaction costs that accumulate over each year. We are very concerned about the internal fees of mutual funds and we go to great lengths to weed out expensive or poorly performing funds. Only the top 5% of funds in each category or asset class we determine as being worthy are positioned for clients. Then, mutual funds are monitored rigorously for performance.
- Dilution – It’s possible to have poor returns due to over-diversification. Since mutual funds can have small holdings in many different companies, high returns from a few investments often don’t make much difference on the overall return.
- Liquidity – A mutual fund allows you to request that your shares be converted into cash at any time, however, unlike stock and Exchange Traded Funds that trade throughout the day, most mutual fund redemption take place at the end of the day.
- Taxes – Capital-gains taxes may be triggered when managers sell securities inside of the mutual funds. This could affect you either positively or negatively depending on the management style of the fund. If the mutual fund is in an IRA or a qualified plan such as a 401k, it may not matter. However, for a taxable account taxes can make an impact due to capital gains or capital losses. Taxes can be mitigated by investing in tax-sensitive funds for taxable accounts.
AmericasRetirementPlan.com offers both mutual funds and ETF’s. The reason for this is to provide choice but also, based on the onboarding process, we may be able to select the optimum choice, ETF’s or mutual funds for your portfolio based on the answers to the questions answered. When you go through the onboarding process the questions you answer are formulated to come to a conclusion which is most likely the best portfolio to be created for you, ETF’s or mutual funds.
Further, even if you choose for AmericasRetirementPlan.com to do the selection for you, if you would rather have mutual funds managed for you or ETF’s we can design either portfolio for you.
Choice – it’s what America was founded on!