Advantages of Mutual Funds

You get full-time, professional money management. Most people do not have the time or skill to select and monitor individual stocks and bonds.

You get reduced risk through diversification because a mutual fund owns many stocks or bonds. You can also pick your level of market risk by choosing particular types of funds (e. g., money market funds to insure your principal will not drop in value, bond funds if you want current income and some stability in your portfolio, stock funds if you want your money to grow over the long term.)

You will earn competitive returns on your investment. Mutual funds can furnish the kinds of returns you need to reach your goals. In fact, by choosing an index fund, (a fund that invests in securities of one of the broadly based market indexes such as Standard and Poor's 500), you can expect to match the market's performance, minus the expenses of running the fund. This is an assurance that no other investment can provide.

You don't need a lot of money to get started. Many funds require only $1,000 to open an account, and some funds require minimum initial investments as low as $250 to $500. Subsequent deposits can be as small as $25 to $100 if an automatic investment plan (AIP) is adopted. An AIP is an arrangement where you agree to have money automatically withdrawn from your bank account on a regular basis, (e. g., once a month or every quarter) and used to purchase fund shares.

You retain ready access to your money. A mutual fund is required to buy back your shares, which makes withdrawals easy. It will mail your check within seven days of the request at the closing price (NAV) on the day it is received. (An exception to receiving NAV at sale time is back-end load funds that charge a redemption fee).

Mutual funds are a cheaper way to get the investing job done. Research and operating costs are shared by the thousands of shareholders. The most efficiently run funds have an expense ratio (the percentage of fund assets deducted for management and operating expenses) of less than 1% a year. Some well-established funds charge annual fees as low as 0.2% to 0.5%. Also, many funds are sold directly through their sponsors with no sales charge-known as «no-load» funds. Funds that charge a sales commission are called «load» funds.

Mutual funds are convenient. They can be purchased (and sold) directly from a mutual fund company by mail and by telephone and from full-service brokers, financial planners, banks or insurance companies. (Important note: when mutual funds are purchased from banks, they are not insured by the FDIC like other bank products.) In addition, some discount brokers have established mutual fund «supermarkets» where investors can own funds from many different fund families in one consolidated account without any sales charges or transaction fees. Earnings from mutual funds can also be automatically reinvested in additional shares. Reinvesting and compounding are keys to building wealth.

Automatic withdrawal plans are available, making it possible to have a steady stream of income for retirement (e. g., withdrawals of $250 per month).

Mutual funds have less risk of bankruptcy or fraud than many other securities because they are highly regulated by the federal government through the SEC, which is charged with assuring that mutual funds and investment advisors follow specific rules of disclosure.

Monitoring mutual funds is simple. Prices are reported daily in the financial section of many newspapers and more in-depth information is available in the Sunday business sections.

Disadvantages of Mutual Fund

If there is a broad market drop, your fund's value will dip with it. The diversification of most mutual funds protects you when one or several securities fall, but not when the whole market takes a downturn. The fact that funds can fluctuate up and down, sometimes wildly, is par for the course and should not deter you from investing or scare you out of the market.

There is no guaranteed rate of return with mutual funds as there is with CDs and Treasury securities. Since risk is higher, the liklihood of greater earnings is increased. You must also expect investment performance to fluctuate.

Unwanted taxable distributions can also be a disadvantage. Funds are required to pay out 98% of their dividends, interest, and capital gains annually. Taxes must be paid on these distributions, even if you never received them but instead reinvested them in additional shares. Unfortunately, sometimes you can also owe taxes even if your fund lost money for the year. For the time being, however, this is a non-issue, if funds are held in a tax-deferred account such as a 401(k) or IRA.

Record-keeping for tax purposes can be hard work. Investors who are not meticulous about keeping track of fund purchases and sales may end up paying higher taxes than are actually owed at the time of sale because of a miscalculation of their cost basis. This is the amount of your original deposit, plus additional contributions and reinvested dividends and capital gains. The amount of taxes you pay will vary depending on the method you use to calculate your gain or loss (e. g., average price, first-in, first-out, or specific identification). Thus, it is important to keep every annual statement for as long as you own the fund.

Basis of Mutual Funds | The ABCs Classes | Fees and Expenses | The Risks of Investing | Selecting Fund | Duties of Mutual Funds | List of Indian Mutual Funds