With the diversity they offer, mutual fund stocks are a safer way to invest in stock markets than just directly buying stocks of different companies. However, they are not without their flaws. Before making any investments in them, one should know their different types and their relative advantages and disadvantages.
The first thing an investor needs to know about mutual funds are their different types. The most common type is the stock or equity funds. Since they are invested primarily in stocks that can rise and fall greatly with the market, they are the most volatile. However, they offer the best returns over the long term. Among these funds, investors can choose from varying levels of risk and return with aggressive growth funds investing in less proven companies offering the most risk but the highest potential returns.
Bond funds, also referred to as fixed-income funds, invest in government and business debt. While they do not offer high returns, they are relatively safe and generate cash flow through dividend payments. However, keep in mind that the issuers of the debt they buy do fail to pay at times.
Money market funds can only invest in the safest, short-term investments in government and corporate debt. The value of the investment will only vary a small amount, if at all, from the NAV (net asset value). However, they historically offer the lowest rates of return.
Why mutual fund stocks are attractive
The major attraction of mutual funds is that they offer diversification to investors while freeing them from having to watch and manage so many different stocks. Mutual funds have the resources to invest in a diversity of stocks and markets that an individual investor would find impossible. Since the holdings of the fund are under the supervision of professional managers, fund investors generally feel they do not have to watch the stocks in the fund closely if at all. They also offer an easy way for investors to make regular, monthly purchases in the market without having to constantly place stock orders.
Furthermore, with so many types and families of funds, investors can invest in international and other markets they never could enter on their own and switch the types of investments they have.
Criticisms of mutual fund stocks
Mutual funds are not without their drawbacks though. One is their fees. Since they are managed professionally, part of the investments made in these funds must go to their upkeep. Especially when compounded over time, these fees can add up to significant sums of money. Also, these fees are charged regardless of if the fund generates a profit or a loss.
Furthermore, for all these fees, mutual funds generally do not beat the market. This is one reason why another type of fund, the ETF, has become increasingly popular.
Finally, mutual funds often buy and sell their positions. This means they generate taxable events frequently. This can lead to tax liability being generated by a fund even in a year when its value dropped overall.
In spite of their drawbacks, mutual funds are a very established fixture on the investment scene and offer services many people value. These conveniences and advantages mean mutual funds are likely to remain the primary way many people invest in stocks.