As an investor, you may have heard that a mutual fund is a less risky investment option in comparison to stocks, but you may not actually know what is a mutual fund. Before you make a financial investment, it is wise to learn what is a mutual fund and how does it work. By taking steps to educate yourself about this investment option, you can be a more informed investor who is in better control of your money.
The Concept of a Mutual Fund
Before you fully explore what is a mutual fund, you may want to know how these funds first developed. Mutual funds as we know them today rose to prominence in the United States in the 1980s. However, they actually existed in various forms long before this. The exact origins are unknown. Still, there are many examples of investors pooling their resources to moderate risk. This includes in Great Britain, the Netherlands, Switzerland, and other areas as far back as the 1800s.
Prior to the 1920s, the mutual fund style of investing dealt largely with investors pooling funds to mitigate business and trade risk. Examples include bringing together multiple investors to fund shipping trade. In 1928, the United States met its first mutual fund. It dealt primarily with stocks and bonds, which is the type of fund most investors are familiar with today. These funds grew in popularity very quickly with investors. By 1929, there were more than 720 open and closed-end funds available for investors to choose from. The crash of 1929 brought this to an end. Mostly open-end funds survived the crash.
Over the years, more funds were added to the options to meet different investors’ needs. For example, high growth funds, aggressive funds, and others entered the list. Regulations were also implemented to keep investors safe from unscrupulous behavior. Today, there are more than 10,000 mutual funds for investors to choose from in the United States alone. This provides investors with ample opportunities to find the right funds for their specific needs and growth strategies.
Advantages and Disadvantages of Mutual Funds
With all types of investments that you can choose to invest your money in, there are both advantages and disadvantages. More than that, each individual mutual fund has its pros and cons. This is because the return, the risk, the fees, the up-front cost and more all vary by the mutual fund that you are looking at. While there are numerous pros and cons to consider, a closer look at generalizations will help you to determine more easily what is a mutual fund and if you should make this investment yourself.
Advantages of Mutual Funds
There are several main benefits associated with an investment of mutual funds. They include the following.
- The relative convenience associated with buying a large mix of investments through a stock brokerage. This is particularly true if you make the purchase online.
- This provides you with an easy and fast way to expertly diversify your portfolio. It is because each fund has a great mix of stocks, bonds, and other assets.
- Each fund is professionally managed. This takes the time and stress out of managing your investments.
- You can invest in a wide range of assets under a single fund. This may not be possible otherwise if you are investing only a small sum of money.
It is important to compare these advantages of mutual funds against the benefits of other investments. You need to determine if investing in mutual funds is the right move to make. However, you must also carefully consider the downsides associated with this type of investment.
Disadvantages of Mutual Funds
Just as there are advantages, there are also disadvantages associated with mutual fund investments. These include:
- When you purchase mutual funds through a broker, it will charge a wide range of fees. Fees can erode away your profits.
- Mutual fund prices are only updated daily. Stock prices are updated continuously throughout the trading day.
- Capital gains are distributed to investors regularly. This is opposed to stocks and bonds. Here, capital gains are only a factor at the time of sale.
- Because of the structure of mutual funds, you may actually have to pay capital gains on these investments even if you record a financial loss. This can cost you a substantial amount of money.
While the overall return on mutual funds is substantial, the reality is different. There are expenses and other downsides that investors must consider. Do this before you make this type of investment.
It can be difficult to determine which types of investments you should make. Some want great control over the diversification of their assets, and mutual funds may not be ideal in this case. However, others want to enjoy great diversification without the need to spend so much time managing their portfolio, or they want to enjoy the benefit of greater diversification with limited available capital. If you have decided to invest in mutual funds and if you now understand what is a mutual fund, you may be ready to start exploring some of the funds available. We invite you to take some time to share your thoughts, comments and personal experiences regarding mutual funds today.