These days we are all looking for a little something extra when we finally retire. There are many implications that our social security nest egg might not be enough, if it’s there at all, once we finally reach retirement. But who knows enough about other investments without hiring expensive accountants and portfolio managers? You might be able to get good investment advice from right under your nose. Mutual funds are a good way to start out small in investing, and don’t require you to put down a ton of money or risk your entire life-savings. Here are the pros and cons of investing in mutual funds.
Diversification. Investing in mutual funds helps spread your holdings across a number of different investments, which reduces the effect of any specific financial downfall. For instance, because mutual funds can contain hundreds or thousands of securities, investors aren’t likely to be fazed if one of them doesn’t do well.
Expert Management. Many beginning investors lack the financial know-how to manage their own portfolio. However, non-index mutual funds are managed by professionals who dedicate their careers to helping investors receive the best possible return on investment.
Liquidity. Mutual funds, unlike some of the individual investments they may hold, can be traded daily. Though not as liquid as stocks, which can be traded during work hours, buy and sell orders are filled after market close. This is not a 9-5 trade, which makes it easy for the common investor to make informed decisions.
Affordability. For as little as $50 per month you can own shares in Google or a host of other expensive securities via mutual funds. Investments in many of the bigger names can be purchased anywhere from $50-$100, which makes them reasonably accessible.
No Control Over Portfolio. If you are investing in a mutual fund you give up all control of your portfolio to the money managers who run it. If you are someone who is particular about where the money is being used, you won’t be able to dictate many of your portfolio decisions.
Capital Gains. Anytime you sell stock, you’re taxed on your gains. However, in a mutual fund you’re taxed when the fund distributes gains it made from selling individual holdings – even if you haven’t sold your shares. If the fund has high turnover, or sells holdings often, capital gains distributions could be an annual event. That is, unless you’re investing via a Roth IRA, traditional IRA, or employer-sponsored retirement plan like the 401k. So in a sense, the fact that the funds are distributed over multiple securities can turn around to bite you in the end.
Over-diversification. Although there are many benefits of diversification, there are pitfalls of being over-diversified; it’s sort of a double edged sword. The more securities you hold, the less likely you are to feel their individual returns on your overall portfolio. Therefore, though the risk in investing in mutual funds will be reduced, so too will the potential for gains.
Cash Drag. Investors still pay to have funds sitting in cash because annual expenses are assessed on all fund assets, regardless of whether they’re invested or not.