While it can be confusing, the answers to the following three questions will help you navigate the mutual fund waters—from how they work to how to add them to your investment portfolio. What Is a Mutual Fund? For all intents and purposes, mutual funds serve as an alternative for investors who can’t afford an individually managed account. Mutual funds are formed when investors with smaller amounts of capital, pool their money together and then hire a portfolio manager to run the consolidated pool’s portfolio—subsequently buying different stocks, bonds, or other securities in a manner consistent with the fund’s prospectus. Each investor then receives their respective piece of the pie while sharing the expenses, which show up in something called the mutual fund expense ratio.
Building Wealth Mutual Funds. Mutual funds are the best way for the most people to build wealth. Not everyone can become a successful business owner or rise to the top ranks of a large corporation. But saving and investing for the long term with mutual funds can be accomplished by almost anyone. While there are a plethora of investment options (individual stocks, ETFs, and closed-end funds, to name a few) a mutual fund can offer a simple, efficient way to invest for retirement, education or other financial goals.
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Mutual Funds Lack Liquidity. How fast can you get your money if you sell a mutual fund as compared to ETFs, stocks and closed-end funds? If you sell a mutual fund, you have access to your cash the day after the sale. ETFs, stocks and closed-end funds require you to wait three days after you sell the investment. I would call the “lack of liquidity” disadvantage of mutual funds a myth. You can only find more liquidity if you invest in your mattress.
Once you know your investment objective, which will include the number of years to invest and how much risk you’re willing to take, you can choose the best mutual fund or funds for you. And depending upon the types of mutual funds you use, the ongoing maintenance required may be little to nothing. Mutual Funds Offer Professional Management. One of the primary reasons investing mutual funds is easy is because they’re professionally managed. Rather than researching, analyzing, buying and selling stocks or bonds yourself, you have a skilled money manager doing it for you. Professional management is at the core of how mutual funds work: When investors buy shares of mutual funds, they’re pooling their money together. Managers use this pool of money to buy the stocks or bond securities that end up forming one portfolio.
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.