Although Mutual Funds and their purpose may seem complicated to beginner investors, they can provide a simple, yet powerful tool to beginner and experienced investor portfolios alike. If mutual funds are so important, it begs the question what are mutual funds and what are their most prominent pros and cons?
In this article, we will cover the basics of mutual funds, their inner workings, and whether or not mutual funds could be a beneficial addition to your portfolio.
What is a Mutual Fund?
Mutual funds at their core are simply a business like any other, except instead of focusing on providing key goods and services to customers, mutual funds are businesses designed for investment. They are a collection of a multitude of assets that in return provide owners with ample opportunity for diversification and returns.
Just like a company, mutual funds are run by a group of professionals, in this case professional money managers, that will manage a collection of assets for individual investors in an attempt to produce capital gains and income. Nevertheless, not all mutual funds are alike and depending on their allocations mutual funds can be made up of differing securities, bonds, and other equities.
How are Mutual Funds Valued?
Overall, investors have ownership of a proportion of a mutual fund's assets and the overall price, return, and value of a mutual fund's shares is determined by an aggregation of its vast ownership of varying securities and their respective underlying performance.
Additionally, mutual fund shares are calculated using the NAV, or Net Asset Value per share. This calculation is made at the end of trading by dividing the total value of assets in the fund by its outstanding shares. Mutual fund shares can be purchased and sold at these calculated values that update at the close.
The Pros of Mutual Funds
Mutual funds can be a powerful tool for investors looking to diversify their holding across vast and varying asset classes.
The first and most apparent pro to mutual funds is their ease of access for investors. Most 401k and retirement funds are placed in mutual funds and they are often readily available for purchase through most brokerage firms. Additionally, these funds provide investors with immediate diversification and professional money management, providing value for investors that are uncomfortable with, or don’t have the time to research, investing in individual securities.
Furthermore, mutual funds are often highly liquid and are abundant, allowing investors access to a plethora of different combinations of equites, bonds, securities both in U.S. markets and abroad. Some brokerage firms and investors use mutual funds to gain exposure to foreign or developing markets with which they have little knowledge or access. Mutual funds also have the benefit of investing in some restricted IPOs and other assets that may be out of reach for most investors, due to the cost of capital required.
The Cons of Mutual Funds
Although mutual funds can provide investors with a multitude of benefits, there are also a few cons that prevent some investors from adding them to their portfolios.
The most popular qualm investors have with mutual funds is their tendency to charge high fees and expenses to their clientele. Mutual funds, like other businesses charge for their services and investors often have to stomach these fees in exchange for the diversification and other benefits the funds can provide, although some brokerage firms are now providing select lists of specialized commission-free funds.
Furthermore, investors that invest in mutual funds could find themselves frustrated with the transparency of some funds and additionally struggle to compare and contrast different options. Mutual funds can be quite difficult to compare, due to their varying fees, costs, and other differing assortments of assets and fund strategies.
Lastly, although mutual funds provide many performance benefits, they also can be a detriment to investor returns, due to sometimes over diversified portfolios and their high cash balances that could be utilized for further returns in the hands of individual investors.
The Importance of Mutual Funds
Despite having some cons, mutual funds can be a powerful tool for individual investors, due to their immense benefits. Furthermore most retirement funds automatically place investors’ money into an assortment of such funds. Knowing where your money is going and how it is being managed by these funds is extremely important and can make the difference in your retirement, whether it be in the form of increased returns, or simply building up supplemental income to allow increased financial freedom and opportunities.
Due to the complexity of some funds and their somewhat intricate differences, it can be difficult to determine which, if any mutual funds are right for you. We at Wall Street Survivor want to promote financial literacy and education as much as possible. If you decide that mutual funds could be for you, we recommend checking out our other articles regarding the selection of mutual funds.