Despite the popularity of mutual funds, they have both advantages and disadvantages. Wise investors take the time to understand their investments before committing their capital. Understanding the advantages and disadvantages of mutual funds will make you a better investor.
Advantages of Mutual Funds
Easy Diversification - Many mutual funds are actively managed portfolios that are well diversified. Funds are diversified with the objective to improve performance through seeking the highest rate of return at the lowest possible risk.
Professional Portfolio Management - When investing in a mutual fund, your money will be managed by a professional investment team. More often that not, these money managers have plenty of experience, education and a dedicated support team.
Liquidity - Mutual funds provide their investors the ability to buy and sell shares whenever they want or need to. This can prove to be a real advantage in times when optimal buying or selling conditions exist in the marketplace.
Reinvested Earnings - Exponential portfolio gains can occur when earnings (realized gains and dividends) are reinvested into new positions. Mutual funds make it easy to reinvest your earnings, many ask you if you would like to reinvest earnings when opening a new account or position.
Disadvantages of Mutual Funds
Fees and Expenses - The advantages of mutual funds, such as professional management, come with a price. Funds with low management requirements like index matching funds have lower fees and expenses, whereas niche funds will require higher maintenance and will come with a higher cost.
Not Insured - Unlike savings accounts, investments in money markets and certificates of deposits, the capital you place in a mutual fund will not be insured by the FDIC against loss. The value of your mutual fund will rise and fall alongside the stock market and losses can be sustained in the short and long-run.
Below Average Performance - Unfortunately most mutual funds underperform common market indices such as the S&P 500 and Dow 30. In light of this fact, its sometimes better just to invest in a variety of different index matching ETFs.
Limited Investing Strategies - Mutual fund managers are limited in the types of investments that they can make, this often limits their ability to take advantage of strategic opportunities such as buying options and shorting stocks. This is one of the main differences between mutual and hedge funds.
Investing in mutual funds comes with a few advantages and disadvantages. However in most circumstances (and financial plans) the pros completely outweigh the cons.