- Mutual funds are wonderful investments for people who have little time or interest in tracking a portfolio of investments themselves. Such people might lack the market savvy necessary to make sound investments and might not have enough capital to make the process worth their time. Other benefits of mutual funds include their ability to capitalize on economies of scale and cheaply create a widely diversified portfolio for small investors.
- There is a great variety of mutual funds in the world today. They range in risk, size, purpose, fee structure, what they invest in, and what their goals are. Not all mutual funds are diversified and an investor who wishes to mitigate risk by having a diversified portfolio should consider buying several mutual funds or a mixture of mutual funds and other investments. Having a general idea of what your fund is investing in is very important, as it will have a huge impact on what you can expect in terms of risk and return.
- One drawback to investing in mutual funds is a lack of personal control. Another is that, like many investments, returns will fluctuate. A third downside is the fact that based on historical data most mutual funds will not beat a market index fund. A market index is a basket of stocks that tracks the performance of the market at large, like the Dow Jones Industrial Average. Presumably, professionals would be expected to do better than this benchmark, which essentially equates to average performance.
- The efficient market hypothesis is a theory that stocks are always correctly priced because all available information is incorporated into a stock's price. If that theory is true, and it is not universally accepted, there is no point in paying investment experts to pick stocks. However, even if you believe this theory, you might still want to buy mutual funds. There is a certain type of mutual fund called index funds which buy stocks to track performance of the index. These funds have the advantage of being well diversified and relatively low risk for equity investing. They also can be expected to out perform most other mutual funds (remember most will underperform the index) and there are low fees, because the fund's investment team does not have to decide which stocks will outperform the market.
- Mutual funds are not guaranteed by the FDIC like bank deposits. They carry some degree of risk for investors. Some funds will be substantially riskier than others. It is important for investors to research mutual funds carefully before buying. However, mutual funds can be a great way to lessen the burden of research on individual investors and still allow them to participate in investments which will likely yield them a higher return.
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