Why Invest in Mutual Funds and What They Are

The majority of investment activities is carried out by institutional investors, including mutual funds.

They buy and sell large quantities of shares and get preferential treatment on trade commissions.  Although everyone can try investing for him or herself, investment is a profession and requires professional knowledge and expertise, as well as resources.

With a certain degree of share concentration, some mutual funds may even seek board seats of their portfolio companies and try to exert a more active role in corporate governance.  As a result, funds can have more control over their investments and that often leads to better investment performance.

Professional Management

Mutual funds are investment companies that are highly regulated by the Securities and Exchange Commission for the protection of the investing public.  Like corporations, mutual funds have boards of directors to oversee fund management and the boards appoint registered investment advisers for its portfolio management.  Professional money managers have the expertise and resources to perform in-depth analysis for any investment made.

There are many research organizations such as Morningstar that track and compare mutual fund performance, which creates competition and encourages fund managers to deliver better returns for investors.

Fund Diversification

Most mutual funds are actively managed and invest in a diverse range of securities, which individual investors without enough capital can hardly match.

There are well over a thousand mutual funds to choose from and they represent a full range of industries and companies, from value or growth stocks, small cap or large cap companies, to domestic or emerging markets, to bonds and various cash equivalents.

Investors should study a fund’s prospectus and learn about its investment objectives and investing methods in order to make informed selections.

Fund Liquidity

what are mutual funds

Mutual funds can be a great investment in your portfolio.

Buying mutual fund shares has almost the same level of liquidity as trading stocks.

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By law, mutual funds must redeem their fund shares upon investor request.  Trading mutual funds can be easily done through either placing orders with a broker or directly contacting fund companies.

Mutual fund share value, known as net asset value NAV, is calculated and announced once at the end of the trading day based on share prices of a portfolio’s underlying securities.  Normally prior day NAV is applicable for share redemption application received before a cut off time.

Mutual Fund Popularity

As of July 2010, the U.S. combined mutual fund assets under management is over $10 trillion.

Not only have mutual funds been popular among individual investors, but also for the nations massive 401(k) plans that have continued to have their retirement money invested in mutual funds.  For 401(k) administrators, when it comes to provide investment choices for a plan’s employees, it seems that mutual funds are the automatic option.

The mutual fund industry has also lobbied hard to secure this valuable funding source.

Buyer Beware

Though mutual funds have many clear advantages as an investment vehicle, they aren’t all created equal.

Make sure the mutual funds you invest in meet your investment goals and aren’t full of fees, such as loads, that will sap your return.  Watch who has managed the fund and how long they have run the fund and what they have invested themselves in the fund.  Take a close look at the prospectus to see the underlying investments.

You may find that a fund’s investments don’t match as well as you would like to their description or name.

In all, mutual funds are a great way for a person to invest in a broad variety of investments without having to buy each individual security. Chosen carefully, mutual funds can help create and grow wealth for years to come.

What do you think of mutual funds?  What do you look for in a fund?

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Published or updated October 25, 2012.

Comments

  1. True confessions: I do not have the expertise nor the interest in researching which companies to invest in. I therefore use a diversification of mutual funds, trusting that the professional managers are worth their salt. Could I do better? I really don’t know. Should I do more homework on specific investments? Maybe, but then again, I am paying those managers to do that for me.

    • As easy as it is to actually invest, it’s much more difficult to know what you are doing. That’s where an instrument like mutual funds becomes useful.

      And you don’t always have to put so much trust in the fund managers either. If you invest in an index fund then the manager should be following the index for the most part (thought it’s not always exactly the case). This cuts down on expenses and gives you a clearer benchmark to gauge the performance of the fund.

  2. What d you think about Vanguard accounts? I’ve heard only good things about them, but I wanted to hear your take.

    • Supposedly Vanguard carries some of the lowest expense rates around and they have a good amount of index funds to invest in. Still, you have to do your research before buying an fund.

  3. I am a complete Boglehead (follower of John Bogle) and I highly recommend low cost index funds. Statistically speaking, it is very rare for a fund manager to beat the S&P 500 over a very long time frame (30 years). If you really want to *invest* your money, you should buy an index fund and sleep well at night. Fund managers are just stock pickers… hot one year, cold the next. I read an article right after the stock market crashed about this *hot* fund manager who basically lost like 60% of his value because he poured $ into Fannie Mae and other real estate funds. His track record was ruined and he was being sued by some police department for screwing up their pension! But 5 years ago he was a superstar…. :P

    • And for the readers out there that don’t know, Bogle was instrumental at Vanguard, creating low-cost index funds.

  4. What are your thoughts of assembling a portfolio of ETS to mimic a mutual fund holding?

    • ETF’s can certainly be a viable alternative to mutual funds. Many brokerages have ETF’s that match the mutual fund counterpart. The big difference is commission fees. Mutual funds tend to not have them while with an ETF you will pay a commission each time you buy or sell (not always though, check the brokerage). Depending on your goals and investing plan you can find yourself paying a lot of commission costs. On the flip side, many ETF’s have very low expenses.

      Another consideration is that ETF’s trade like stocks and as such their price could be higher than the value of the holdings if there is demand for the ETF. A mutual fund will sell for its NAV.

  5. I have been putting a little amount of money in a mutual fund and plan on letting it grow for 10 years. Although the markets are terrible and the fund keeps losing money despite me putting more in, I’m hoping things will switch. I am with Vanguard and everything has been an easy process.

    • These days I think you really have to invest long term. The markets are all over the place days. If you are adding to your portfolio as prices go down then you are getting more shares for your dollar. If the fund grows in value over ten years you could see your investment balloon up!

  6. Great post, but not one GOOD reason ;)

    Mutual funds fail to beat the market by about their fees … so, if you MUST ‘invest’ at such a simple level, at least buy a super-low-cost Index Fund.

    • I’m all for low cost index funds. But not all mutual funds fail to beat the market (most do though).

      Still, for the average investor, I don’t think picking individual stocks is a better alternative. I believe both Buffet and Bogle have said the average person is probably best off with a low-cost index fund.

  7. I am a bogle head investor too. The only way to go! Great informative post.

  8. Like others have said, I’m a big fan of index funds. They have lower fees than actively managed funds and even if you can find another fund that will beat the market, it probably won’t do so consistently. I prefer the “keep it simple stupid” mantra.

  9. Mutual funds are great way to invest. I really like American funds. They have low fees and well managed. It’s easy to set up monthly automatic deposits from your bank accounts.

  10. I’ve become a big fan of simple low-cost broadly-focused fund investing (mutual or exchange-traded, although I’ve become a much bigger fan of mutual funds lately). Especially with smaller portfolios, the time most people spend trying to time the market or pick the “best” stocks is simply not worth the effort or added risk that it usually involves. Even watching a one-hour episode on CNBC adds up.

    Also, re: most mutual funds don’t outperform the market: I’m sure most home-gamers don’t outperform the market either. I’m not telling you to aim low (i.e. just track the S&P). I’m just saying that, sure most mutual funds don’t beat the market, but that doesn’t mean you’ll make more by hoping Uncle Moe’s best stock tips will work. Some people would be better off buying a low-cost index fund and focusing their time on other parts of their financial plan.

    Two cents :)

  11. So, yes. I agree with you FFB. Great post.

  12. Great overview of Mutual Funds, and I appreciate your important notes advocating for people to investigate, research, and understand the objectives of the fund BEFORE placing their hard earned dollars in the hands of the fund managers.

    This point of due diligence and personal understanding is often stated in the ‘fine print, then overlooked as many people randomly pick how their 401k or IRA will be invested.

    I believe and advocate that one of the best uses of many people’s time and resources is to invest in themselves and their education BEFORE ever putting their money to work (whether in Mutual Funds or something different). This allows people to make better decisions, have greater control over their investment dollars, and to be better prepared for the opportunities or pitfalls that the future may hold.

    To me, not taking the time to invest in yourself and your understanding of an investment is the biggest mistake made by many “investors”, so thank you again for emphasizing the importance of that point several times in this post!

  13. Mutual Fund are very great for new investors, but when picking which fund you want to invest. It is more difficult than picking stock, since there are more mutual funds out there in the market place than stocks. Many researcher said that 90% of fund can’t outperform the market. In my opinion it is better to invest in ETFs like the spider for a market return if you don’t wanna manage your own portfolio. The benefit of ETFs is low cost and with great liquidity.

  14. Great post. In my opinion investing is all about asset allocation and should be based upon one’s financial plan. Mutual funds and ETFs are great vehicles for filling the various style buckets in your asset allocation strategy. I disagree with those commenters who talk about beating the market, however. Investing in my opinion is about controlling risk and allocating your investments in line with your overall goals (retirement, college, etc.).

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