Mutual funds give investors the ability to diversify across a wide variety of investments that they otherwise may not carry in their portfolio as individual securities. Since mutual funds invest in a diverse range of securities and investment options, one mutual fund share actually represents proportionate ownership in each and every investment in the mutual fund’s portfolio. Of most interest to investors is that each share also proportionately represents the profits of those investments as mutual funds are required to pass along profits to their investors by way of mutual fund distributions, which come in several forms.
Balanced Funds: Also called hybrid funds or asset allocation funds, these are mutual funds that invest in a balanced asset allocation of stocks, bonds, and cash. The allocation usually remains fixed and invests according to a stated investment objective or style. For example, Fidelity Balanced Fund (FBALX) has an approximate asset allocation of 65% stocks and 35% bonds. It considered a medium risk or what industry experts might call a moderate portfolio. Vanguard also has an outstanding index balanced fund, Vanguard Balanced Index (VBINX), which is suitable for investors looking for moderate risk. Balanced funds can be ideal for beginning investors because they are well-diversified and can, therefore, be used as stand-alone investments or as core holdings to begin a larger portfolio.
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Mutual Funds Have Hidden Fees. If fees were hidden, those hidden fees would certainly be on the list of disadvantages of mutual funds. The hidden fees that are lamented are properly referred to as 12b-1 fees. While these 12b-1 fees are no fun to pay, they are not hidden. The fee is disclosed in the mutual fund prospectus and can be found on the mutual funds’ websites. Many mutual funds do not charge a 12b-1 fee. If you find the 12b-1 fee onerous, invest in a mutual fund that does not charge the fee. Hidden fees cannot make the list of disadvantages of mutual funds because they are not hidden and there are thousands of mutual funds that do not charge 12b-1 fees.
S&P 500 Index Funds: Index funds can be a great place to begin building a portfolio of mutual funds because most of them have extremely low expense ratios and can give you exposure to dozens or hundreds of stocks representing various industries in just one fund. As their name suggests, index funds simply hold the same securities that are found in an index. S&P 500 Index funds invest in approximately 500 of the largest U.S. companies. Index funds are passively managed, which means their primary objective is to mirror the holdings and performance of an index and therefore costs to operate these funds are extremely low. Therefore, you can meet the initial goal of getting a low-cost, diversified mutual fund when you buy index funds. For more on index funds, check out our Index Investing FAQ page. Again, mutual fund companies like Vanguard, Fidelity and T. Rowe Price are good places to find the best index funds. You can also look at Charles Schwab.
In a mutual fund, the value of your shares goes up and down as the value of the stocks and bonds in the fund rise and fall. For the average investor to have the same exposure to those investment options and potential profits on their own would be extremely costly both in terms of the actual investment dollars and in terms of time. Additionally, investing in a mutual fund is generally a cost-effective way to gain access to professional money management. Were you to try and invest in individual securities and actively manage them the way a mutual fund’s manager does, it could very easily become a full-time job. In order to make wise investment decisions when you buy individual stocks and bonds yourself, at the very least you’d have to have the knowledge to do extensive research on various types of businesses in general (automobile, construction, medical) and on specific companies (GE, IBM, Microsoft).