Understanding Mutual Funds Investing – Advantages and Disadvantages
People invest money in stocks and bonds for a wide variety of reasons, such as prepare for retirement or build their kids college funds. However, many investors avoid choosing individual stocks or bonds for their investment portfolios because they do not have the experience, time or confidence to make the appropriate choices. In addition, risk adverse investors would rather avoid the possibility of loss associated with investing their hard-earned money into the stock or bond of a single company.
Mutual funds provide investors the opportunity to invest in the capital markets, diversify their assets and have their investment overseen by professional money managers. Though mutual funds have risks and investors must pay fees and expenses, which reduce their returns, most people find they can reduce worry and anxiety by spreading their money among several companies.
Similar to investing in equities or bonds, investors should gain a clear understanding of how mutual funds work. Developing knowledge of the upside and downside of these instruments, and how to select mutual funds that meet your objectives and tolerance for risks, ensures you make informed choices for your investment portfolio.
Mutual Fund Attributes
Mutual fund companies pool funds from thousands of investors. The managers of these firms invest the money to accumulate portfolio holdings consisting of stocks, bonds, money markets, real estate and other assets. Instead of purchasing individual assets on the secondary market, such as the NASDAQ, the American Stock Exchange or New York Stock Exchange (NYSE), investors buy shares directly from the mutual fund companies.
Each fund investor receives an ownership share of the fund’s holdings based on the size of the individual’s investment. The investor also shares in the gains or losses of the fund.
As new investors buy shares in a fund, the fund’s management creates shares to fill the orders. When a mutual fund becomes too large, the managers close the fund and stop selling shares.
Net Asset Value
A mutual fund company sells fractional shares of the fund to individual investors. Each fractional share of a mutual fund has a market price called the “net asset value” (NAV). The NAV represents the market value of a fractional share for “buy “and “sell” transactions. Fund managers calculate the NAV by dividing the portfolio’s total value, which consist of securities and cash, minus the fund’s liabilities, by the number of outstanding fractional shares.
If the fractional shares of a fund equal $9.25 per share and you invest $200, the mutual fund company credits your account with 21.622 shares. This does not include transaction costs.
Advantages of Investing in Mutual Funds
For investors who would like to buy stock and bonds, but have a low tolerance for market gyrations, mutual fund investing provides a more suitable alternative. Investors can start reaping the benefits of mutual fund investing with a small amount of money. Many funds allow investors to open accounts for as low as $1,000. Investors can also open IRAs or direct deposit accounts for a smaller minimum amount. Most funds permit investors to add to their accounts in smaller increments after opening the initial account.
A mutual fund can have between 50 to 500 stocks. The average fund diversifies holdings among 100 stocks. This degree of diversification ensures the problems of a single stock have a limited effect on the value of the total fund.
In addition, investors rely on the fund’s professional manager to research, buy and sell stocks and monitor equities. Mutual funds offer investors a high degree of liquidity. Investors can redeem shares at the NAV. Funds investors must pay transaction fees and charges.
Disadvantages of Mutual Fund Investing
One of the primary disadvantages of mutual fund investing concerned the annual fees sales charges and other costs associated with the fund. In some cases, investor will also have to pay capital gain taxes on distributions received from investments. Unlike stocks, investors do not have a voice in the precise make-up of the fund or the management decision regarding the purchase and sell of stocks.
As it relates to prices, investors can obtain real-time pricing information on stocks. However, the price of mutual fund shares depends on the NAV, which companies must calculate a minimum of once a day.