When it comes to investing, diversifying your portfolio is rule No. 1. Putting all of your money into one type of financial product is risky because if that investment devalues, so will your entire portfolio. By sprinkling your funds across different investment opportunities, you reduce your risk of loss. One way to get instant diversification within a single investment is to buy a managed fund, also known as a mutual fund.
What Are Mutual Funds?
When you buy a mutual fund, you aren’t making a direct investment — rather, you buy shares in the fund, the value of which represents your share in a pool of underlying assets. Mutual funds contain a variety of securities that tend to target a specific industry or investment style. For example, some managed funds invest only in bonds or income-producing securities, whereas others invest primarily in stocks.
A seemingly endless array of funds are available, such as high yield or government bonds, or small-cap or foreign stocks. Some managed funds invest in both stocks and bonds; these are called balanced funds.
In order to lower the risk of owning any one individual security, managed funds spread out investor funds over tens, hundreds or even thousands of different investments, thereby providing market access to investors who might not otherwise be able to participate. However, not all funds are good investments for all investors; the funds you choose should match your financial goals.
Before investing, you should understand mutual funds’ advantages and disadvantages.
Advantages of Managed Funds
Managed funds have plenty to offer investors. Here are some of the advantages of this type of investment.
Most investors don’t have enough money to buy tens or even hundreds of different types of investments to achieve true diversity. By pooling funds with other investors, a mutual fund buyer benefits from this vast pool of money by accessing a wide array of securities.
Easy for Novices to Get Involved
You don’t have to be a sophisticated investor to buy a managed fund. So many different types of funds are available that it can be relatively easy to find one that matches your investment needs. You can also typically buy or sell fund shares on any business day.
Mutual funds are essentially an all-in-one package. Rather than buying numerous individual bonds, stocks, exchange-traded funds or other investments, one mutual fund can hold them all for you. You can track the price every day in the newspaper or online, and it’s as easy to sell a fund as it is to buy one.
One of the prime benefits of a mutual fund is that, for a minimum investment, even a novice investor can have access to a professional money manager. A fund manager will watch your investment on a daily basis and make strategic moves to help achieve the fund’s objectives on your behalf.
Low Minimum Investment Required
Whereas many funds have investment minimums of $1,000 to $3,000, some mutual funds cost just $100 to get started. Most funds allow a systematic investing plan, in which you can contribute small amounts on a regular basis — monthly or quarterly, for example — with the money automatically transferring right out of your bank account. A systematic plan can help take emotion out of investing.
Disadvantages of Managed Funds
Before you commit to investing in managed funds, you should understand the negative aspects of this kind of investment. Here are the disadvantages you should consider before taking the plunge.
Because you’re hiring a professional money manager to invest your funds for you, expect to pay fees when you buy a mutual fund — even if the fund loses money. It can be confusing to understand exactly how much you’re paying because there are many different ways a mutual fund can cost you — from front-end sales charges you pay at the time of purchase to ongoing annual fees and back-end loads you pay if you sell a fund.
Performance Is Not Guaranteed
Although your money is professionally managed in a mutual fund, there are still no guarantees. In a bad market cycle, even the best of managers can lose money, regardless of their past track record.
Lack of Control
Although you might not have the time or investment knowledge to pick your own securities, it can be discomforting for some to hand over complete control of their money to a stranger. If you have a great fondness for IBM stock, for example, there’s nothing you can do to stop your manager from selling it if that’s his decision.
Mutual funds are required by law to pay out any dividends and capital gains they earn to shareholders, and those distributions might be taxable. Even if you reinvest those distributions into more shares of your mutual fund and never receive the cash in your pocket, you’ll still be responsible for the tax.
Find Out: What Is Tax-Loss Harvesting?
A well-chosen managed fund can help you achieve your financial goals. As there are thousands of funds to choose from, research is critical. You can get essential information regarding fund objectives, fees and expenses in the prospectus that all fund companies are required to provide.