An Introduction to Investing in Mutual Funds
Mutual funds pool investor's capital together to make individual security purchases, ranging from stocks, bonds, cash and real estate. The combined investment purchases are referred to as the portfolio and the individual investors will share in the profit and losses of the mutual fund based upon their percentage ownership. With any investment, it is important to understand the advantages and disadvantages in order to make the best investment decision possible for your goals and objectives.
Mutual funds are popular investment vehicles for a variety of investors as they offer several advantages, including: diversification, professional management, and liquidity.
Diversification- One of the cardinal rules for investing is diversification, as it is a tool used to manage investment risk. Diversification can refer to mixing investment capital between investment types or asset classes. With over 20 different asset classes to select from, it can be challenging and costly for individual investors to achieve. Mutual funds offer investors diversification within each mutual fund as well as they are offered for almost every asset class, allowing a portfolio to be built based upon individual risk tolerance and investment objectives.
Mutual funds also offer diversification for individual investors without the need for a large amount of capital. By purchasing shares of a variety of mutual funds, an investor may be able to achieve their desired diversification with a fraction of the capital required to purchase the same portfolio of individual stocks.
Liquidity- Some investments require a minimum time frame to hold prior to liquidation, some institute back end sales fees at the point of liquidation and others have small markets, making it challenging and even costly for investors to liquidate their investment. Mutual funds transact at the close of the business day for the fund's net asset value (NAV) and are often more liquid than many other investment choices for investors, making it easy to buy and sell.
Professional Money Management- Most mutual funds offer a professional money manager to the investor when they are purchased. Professional money managers research and execute the buy and sell transactions within the fund. As an individual investor, a professional money manager will eliminate the need to research and make buy and sell decisions for their respective portfolio.
While there are numerous advantages to investing into mutual funds as an individual investor, there are several disadvantages to also consider, including fluctuating returns, costs and potential tax liabilities.
Fluctuating Returns- While some investments offer a fixed or guaranteed return, the value of mutual funds will fluctuate with the supply and demand factors of the economy, meaning that there is a risk for a loss of capital. Also, due to the daily fluctuations in value for mutual funds, it is important to understand when the ideal time to liquidate the investments is.
Costs- While there are costs associated with almost any investment, mutual fund fees can vary drastically. There are several types of costs that an individual investor should consider, such as shareholder fees, front end fees, back end fees, maintenance fees and professional management fees.
Taxes- Mutual funds present the issue of annual capital gains taxes depending on the fund manager's trading activity which is passed to the individual investor based upon share ownership. Also, the investor will also have to pay capital gains taxes when they sell their mutual fund if there was capital growth.
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