Investing in Mutual Funds
How does an investment in a mutual fund compare to investing in individual securities?
- Professional Management: The biggest advantage gained from investing in a mutual fund is access to professional money managers. Few people have the time and expertise necessary to manage their own portfolios, and a mutual fund provides an inexpensive way to access sophisticated investment management.
- Diversification: By virtue of their size, mutual funds are able to invest in a large number of securities. A diverse mix of securities can reduce overall portfolio volatility since the impact of one poorly performing stock can be offset by a better-performing security. The more stocks that are held, the less one security can impact the overall result. Large mutual funds typically own many stocks in diverse industries. An individual investor would not be able to create a similarly diversified portfolio with a small amount of money.
- Liquidity: A shareholder in a mutual fund can sell shares at any time without worrying about the liquidity of any given stock held in that mutual fund. Since the shares of the fund are valued at the market’s close each day, the shareholder would receive the fund’s current market value at the closing price (NAV) regardless of what time the sell order was placed during that day.
- Simplicity: Most mutual funds require only a small initial investment, and shares can be easily purchased in a variety of ways including online. Mutual fund companies offer many convenient services for shareholders, including online account access, automatic investment and withdrawal programs, and reinvestment of distributions.
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Can’t investing in mutual funds be risky?
Certainly any investment carries the risk that you may lose money, and mutual funds are subject to risk. Mutual funds, unlike bank savings accounts and certificates of deposit (CDs), are not insured by the federal government. Mutual fund prices fluctuate with changes in the financial markets, and may go up or down in value like any stock. It is important to look at mutual fund investments with a view toward the long term, as staying invested over longer periods can reduce the impact of short term fluctuations.
Mutual funds may also offer several advantages in terms of managing risk. As previously discussed, mutual funds are diversified among many securities to mitigate the risk associated with any single holding. They are also highly liquid, and investors can generally redeem shares at any time for the current market value. Significantly, the mutual fund business is one of the most highly regulated in the United States, and the SEC carries out regular audits of mutual fund companies. Independent directors oversee funds’ activities, while independent auditors scrutinize their financial statements and major financial institutions maintain custody of fund assets. Shareholder reports and other communications, as well as marketing materials, are reviewed by the National Association of Securities Dealers (NASD).