FAQs: Mutual Funds-the Pros
and Cons
What Exactly Is a Mutual
Fund?
A mutual fund pools money
from many investors and invests that money in stocks,
bonds, commodities, and other types of securities. The
fund is professionally managed on an ongoing basis by a
fund manager who buys and sells the investments in
accordance with the fund’s stated objectives.
The investors receive shares in the fund, which
they can sell through a stock exchange.
What Are the Primary Ways
to Make Money with a Fund?
There are three common
methods for making money with a mutual fund:
Firstly, the price of a security owned by the fund may
rise, at which time the fund manager may decide to sell
that security and generate a profit for the fund. This
profit is then be shared by the investors in the fund.
Secondly, if a the price of
the fund itself rises in value, then a fund shareholder
can decide to sell his or her share for an increased
price and make a profit on the original investment.
Thirdly, over a period of
time the mutual fund will receive interest on bonds and
dividends on stocks. Subject to charges, this money is
available for distribution to the shareholders in the
fund.
What Are the Advantages of
Mutual Funds?
There are many advantages to
investing in a mutual fund, rather than in individual
stocks and bonds:
- It is a relatively
straightforward, low cost, and safe way of investing
in stocks and bonds without the need to carry out
exhaustive research into individual companies.
- A mutual fund spreads
the investment risk across a large number of
different stocks and bonds so it is likely
that some will perform better than others, thereby
minimizing any potential losses from the overall
portfolio.
- Rather than managing the
investment yourself, a professional, experienced,
and skilled fund manager is doing for it for you.
- Buying and selling your
investment is easy and can usually be carried out by
telephone or over the internet. Your money can be
withdrawn at any time, just by selling the fund—as
with any other stock.
- Minimum investment
levels are relatively low, and there are even
purchase plans available that enable you to spread
the investment monthly.
- Transaction costs are
lower due to the economies of scale.
- Mutual funds are
strictly regulated and investors are automatically
protected from any fraudulent activity by the fund
manager.
.What Are the
Disadvantages of Mutual Funds?
There are, of course, some
disadvantages to investing in mutual funds:
- Occasionally the
spreading of risk can work against the investor, as
small investments in a profitable company may make
little difference to the overall performance of the
fund.
- The tax positions of
individual investors in the fund may well be quite
diverse, and it will not be possible for the fund
manager to take into account any of this diversity
when making investment decisions on their behalf.
For example, a capital gain will occur when a
security is sold by the fund manager. This will have
a profit, and therefore, a capital gain tax
implication for the individual investor.
- The management fees
charged by mutual funds must be paid even if you are
not making a profit on your investment. There are
also other costs to consider that are often hidden
in the ”small print,” such as sales commissions,
operating expenses, and redemption fees.
- Funds are sometimes the
victims of their own success. If a high performing
fund attracts a lot of new investors, then the fund
manager may not be able to find equally attractive
investment opportunities for this extra infusion of
money.
Just because someone is an accountant doesn't
mean they know a thing about managing money. If
you hire an Austin accountant or CPA to manage your
money...find out what they know about doing it. What is
their
track record? If they cannot show you that, then find
someone else.