Mutual funds are arguably the most popular investment vehicle for the majority of investors right now. However, before investing in a mutual funds, you must understand first the good and the bad of investing in them.
What are mutual funds?
There are many different kinds of mutual funds, and they cover many different industries and different asset classes available. It offers a lot of advantages such as advanced portfolio management and risk reduction. However, there could also be high expense ratios and sales charges.
Advanced Management
Buying a mutual fund requires you to pay a management fee. This fee is part of your expense ratio, which is used to hire a professional portfolio manager that will buy and sell stocks bonds, and other assets. The expense is relatively a small price to pay if you’re getting professional help.
Dividend Reinvestment
There are dividends and other interest income sources that can be in the fund. You can use them to purchase additional shares in the mutual fund, making your investment grow faster.
Safety and Risk Reduction
There is also reduced portfolio risk when you’re using diversification. That’s because most mutual funds will invest in hundreds of different securities, depending on the focus of the mutual fund.
Convenience and Pricing
You can easily buy and understand mutual funds. They also have low minimum investments. They are also traded only once per day at the closing net asset value (NAV).
This gets rid of the fluctuation throughout the day. It also offers a lot of arbitrage opportunities for day traders.
Now, let’s look at some of the disadvantages.
High Expenses
As we have mentioned, mutual funds can be expensive. The mutual fund expense ratios and sales charges can easily get out of hand.
You should be very careful when investing in funds with expense ratios that are higher than 1.20%, since they can be considered on the higher end of the spectrum.
As much as you can, find a good mutual fund company that doesn’t have any sales charges. Fees can significantly reduce the overall investment returns.
Inefficient Taxing
Whether you like it or not, you do not have the choice in terms of the capital gains payouts in mutual funds.
Because of the turnover, redemptions, gains, and losses in security holdings through the year, you may receive distributions from the fund that can lead to massive taxes.
Abuses in Management
If your fund manager is abusing his or her authority, different things may happen, such as churning, turnover, and window dressing.
Among other things that the manager may commit are unnecessary trading, excessive replacement, and selling the losers before the quarter-end to fix the books.
Poor Execution of Trades
If you place a fund trade anytime before the cut-off time for same-day NAV, you will receive the same closing rice NAV for your buy or sell position on the mutual fund.
If you are looking for faster execution times, mutual funds may not be the best vehicle for fast execution strategies.