If you’ve ever watched a financial television show, read a newspaper or had a conversation about investing you surely have heard of mutual funds, after all mutual funds are basically the backbone of today’s retirement investment portfolio but do you really understand what mutual funds are and how they work? Most of us don’t.
Essentially mutual funds are a type of investment where you, and thousands of other investors, put your money together in one big pool to be managed by a professional investor known as a fund manager. The fund manager will then take that pool of money and invest it in a variety of stocks, bonds and other investments that they think will make you a return on your investment. Because of this most financial advisers will recommend mutual funds for beginners who have never invested or are fairly new to investing.
Advantages of Mutual Funds
For the average investor it can be tough to buy more than one stock, or at least a handful of stocks, and when it comes to diversifying your portfolio that doesn’t do you much good. As most of us realized over the last few years diversification is the key for not taking a beating when the stock market crumbles for a few years.
Mutual funds on the other hand allow you to invest in many stocks, bonds or other types of investments without having to buy each stock individually. Most funds are literally invested in thousands of securities, some in specific sectors, some in specific types of companies, but typically the risk is spread out across a variety of risk levels and sectors to help you get the diversification you need.
Another advantage of mutual fund is while you may not be sure what stocks or bonds you want to invest in, investing in a mutual fund allows you to generally choose a type of investment but let the fund manager (who generally has a lot of investing experience under their belt) choose the specific investments for you, and choose when to buy more or sell off in a specific security at the right time.
Disadvantages of Mutual Funds
Mutual funds aren’t perfect, in fact no investment is perfect and you need to remember that investing your money in anything could eventually mean you lose it all (If you’re really risk averse just go bury it in a jar in the backyard), but that said Mutual Funds, when chosen correctly, eliminate some risk.
Another disadvantage goes hand and hand with what I said earlier about the fund manager managing your money. Since the fund manager doesn’t call you when he/she buys or sells a security, you have a certain loss of control in your investment. If you’re someone who wants to manage your own finances 100% then mutual funds may not be right for you.
As mentioned earlier since mutual funds diversify your investment across a number of types of investments this can also minimize your return in a good economy but the trade off is safety for your investment. You can always change funds to a more specific fund at a later date but remember the more specific your fund gets the more risk you take on.
Overall mutual funds are certainly a worthwhile investment for a lot of investors and there are thousands of options out there, some good and some bad. As always be sure that whatever you invest in that it matches your investment needs and risk tolerance and you will be sure to find the right mutual fund for your portfolio.
