Mutual funds are companies that pool money from many investors and invest the money in stocks, bonds, short-term money-market instruments, into other assets or securities, or a combination of each of these investments. They have a fund manager who is responsible for investing the pooled money into specific securities, and they provide the ability for investors to purchase stocks and bonds with much lower trading costs than if they tried to do it on their own. When you are investing in mutual funds, you are buying shares and you become a shareholder.
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Investing in this type of fund provides many advantages over stock investing. These advantages are explained below.
Diversification – This is the number one advantage and allows investors to purchase a large number of stocks. Mutual fund investing provides you with portfolio diversification and it greatly reduces your risk.
Liquidity – The investor is able to receive money produced from this type of investment in a relatively short period of time. Income generated from stocks and bonds can be difficult to obtain and CD’s offer no liquidity at all.
Cost – Small amounts of money can be invested at no trading cost. Investors can also invest at regular intervals and receive the same manager, access and investment, as the wealthy stock brokers since mutual funds are non-discriminatory.
Professional Management – With this type of fund you hire a professional manager who researches and trades the market on a regular basis. They are fairly inexpensive and they usually have a support staff devoted to them as well.
While there are many advantages, there are also disadvantages as well. A few disadvantages are explained below.
In the Dark – Investors have a hard time finding out the exact make-up of a fund’s portfolio at any given time. They also cannot influence which securities the fund manager buys and sells or the timing of the trades.
Guaranteed Costs – While there are typically no trading costs, investors must still play sales charges, annual fees, and other expenses despite the performance of the fund. They may also have to pay taxes on any capital gains received even if the fund did not perform well.
Uncertainty in Price – Unlike investing in stocks where you can get real-time pricing information, mutual funds only calculate their NAV (net asset value per share) once a day and this typically takes place after the stock exchange closes. The fund unfortunately may not be calculated until many hours after you have placed your order.
Obviously there is much more information that you should know before you begin to invest in mutual funds. The advantages far out way the disadvantages and almost every successful investor will tell you that you need to invest in mutual funds in order to build a strong portfolio. You may also want to learn about topics such as asset allocation, hedge fund investing, and stock charting. These are additional investing concepts that may be of interest to you as well. Happy investing and good luck!