Mutual funds; the good, the bad, and the ugly
First things first, what on earth is a mutual fund? If you remember, I said that I recommend investing in them as part of your investment portfolio.
According to Investopedia.com, a mutual fund is:
In simple-speak, a bunch of people pool their money with a professional fund manager to take advantage of opportunities not normally available to small investors.
Like all things in life, there are pros & cons to investing in mutual funds.
- Diversification – your invested money is spread among several stocks. This is the opposite of “keeping all your eggs in one basket.” If one company does poorly, the effect on you is limited.
- Professional management – most people (myself included) don’t have the time to evaluate, in depth, all that should be evaluated in a stock before buying it. The fund manager’s only job is to maximize performance of the fund, by picking good stocks.
- Economies of scale – since the fund manager is buying huge amounts of stocks at a time, the transaction fees are much lower than for you or me.
- Mutual funds are liquid assets – they are easy to convert to cash, unlike real estate or bonds.
- Simplicity – investing in mutual funds can be as simple as an automatic bank draft, payroll deduction, or buying from the fund’s website.
- Variety – If there is a sector, stock style, social impact, or any other area you want to invest in, there is a mutual fund for you. In fact, there are more mutual funds than stocks!
- Professional management – Not all managers do as well as they should. Just because the fund is professionally managed, doesn’t mean it performs well. Look at the manager’s track record, along with the funds track record before investing in it.
- Over diversification – if the fund has too many stocks, a great performance by one or a few might have minimal effect on the overall fund value.
- Taxes – all capital gains taxes are passed on to the investors. If the fund is churned a lot (the manager buys and sells the fund assets a lot), investors could be liable for more capital gains taxes. You can look at the fund’s turnover rate, or having the funds as part of a tax-preferred account such as an IRA or 401(k).
- Fees – Fund managers have to be paid. There are costs associated with the administration of the funds. There is no such thing as a free lunch! Fees, referred to as expense ratios, can range from as low as 0.2% for some index funds, to over 2%! The fees will be listed in the fund’s prospectus. These take away from the fund’s overall performance, so look carefully at them. Another fee to be aware of is a sales charge (load). This is how some advisers get paid (think commission on sales); there are many different ideas on the value of advisers and what the best fee structure is (I won’t go into it here), but I will say is that a good adviser is worth his/her compensation. With loads, the more you invest in one fund company, the lower they are, and at some point they usually go away. If you pick a low fee fund and invest regulatory, you may end up paying less in fees than you would buying several different stocks each month on a self service site (up to $9/trade).
It’s important to know the details of a fund before deciding to invest in it. A quality adviser will teach you why he/she recommends a particular fund or group of funds. They will help you pick funds that have a low expense ratio, a good track record of performance over the long term, and are appropriate for your needs. Mutual funds are a great investment tool for average Joes like us!
If you are ready to start investing, I can put you in touch with a qualified investment adviser who has the heart of a teacher! If not, I can get you ready. Contact me today: