Mutual funds have become an increasingly popular investment tool due to their widespread accessibility, the diversification they can provide, and the fact that they’re managed by industry professionals.1 In fact, over 115 million individuals in the US – and more than 52% of US households – owned mutual funds in 2022.2 But despite their place in so many investors’ portfolios, these funds are not free of risk.
To help you better understand how these funds work, what their benefits could be, and the risks you might face when investing in them, we’ve put together this guide detailing some of the things you might want to know about mutual funds before investing.
What is a Mutual Fund?
Mutual funds pool money from their different shareholders and invest them in various assets, such as stocks, bonds, and other types of securities. Each shareholder then receives gains or losses that are proportional to their total investment in the fund.
These funds have a relatively low barrier to entry, offering even the most casual market participants the opportunity to participate in a professionally-managed investment vehicle. As with any type of investment fund, the structure and asset allocation of each mutual fund are guided by its stated investment objective – called a prospectus – which varies from fund to fund. Depending on your individual circumstances and financial goals, certain mutual funds may suit you better than others.
8 Types of Mutual Funds
Before we dive into the pros and cons of mutual funds, let’s take a look at some of the different categories that are available for you to choose from.
Stock funds typically invest in equities. Depending on the fund’s stated goals, its managers may determine its holdings based on things like market cap, dividend structure, or growth prospects.
Bond funds focus on income-generating investments like corporate and government bonds, as well as other investments that offer a fixed rate of return.
Balanced funds, sometimes referred to as asset allocation funds, combine different assets to reduce the risk of overexposure to one particular asset class. They can be divided into two subcategories for fixed and dynamic allocation strategies.
Money market funds function similarly to savings or checking accounts in that they hold short-term debt instruments like US treasuries that are lower risk but offer more modest returns.
International and global funds invest in foreign assets. While international funds only acquire assets outside of the country in which they’re based, global funds can invest anywhere – domestically or abroad.
Specialty funds may be further divided into subcategories, such as:
● Sector funds target specific economic sectors, such as healthcare or technology.
● Regional funds focus on a specific geographic area.
● Values-based funds abide by specific criteria for investments based on shareholder beliefs and values.
Potential Pitfalls of Mutual Funds
While mutual funds vary in size, scope, and allocation strategy, they share some potential pitfalls that bear consideration before deciding whether or not to invest in one:
● High Costs & Fees: Professional management often entails higher costs, and some investors may be put off by the associated fees. These payments differ from fund to fund, but they’re generally required regardless of performance.
● Tax Liabilities: Selling assets triggers capital gains taxes, which get distributed regularly with mutual funds. Since you don’t control when assets are bought and sold within a mutual fund, your annual tax burden may be higher or lower than you anticipate.
● Cash Drag: Mutual fund managers may hold a significant portion of cash to maintain liquidity, but this cash doesn’t earn as much as it might if you invested it elsewhere.
Potential Benefits of Investing in Mutual Funds
Mutual funds may be able to provide a handful of benefits including:
● Portfolio Management: With a professional portfolio manager, you don’t have to worry about doing your own research. Mutual fund managers work full-time to monitor investments, maintain a specific risk/return profile, and align the fund with its stated goals.
● High Liquidity: Buying and selling mutual funds can be relatively easy compared to other investment options. Because they hold a large amount of cash, you can often access your money quickly when you need to.
● Diversification: The wide range of mutual fund categories and the mixture of assets within each can allow you to diversify your portfolio. This method can be cheaper and simpler than researching and buying individual assets.
Interested in Getting Started?
If you’ve weighed the potential benefits and pitfalls of mutual funds and are still looking to invest in one, consider discussing it with a financial professional who can help you identify the fund that best suits your needs. As with any important financial decision, your choice to invest in a mutual fund should be colored by your individual circumstances and investment goals. Reach out to a Financial Planner at Ausperity Private Wealth to learn more.
Best,
Robert (Rory) J. O’Hara III, CFP®, CRPC®
Founder I Senior Managing Partner
References:
Endnotes
1 Boyte-White, Claire. “Why Have Mutual Funds Become so Popular?” Investopedia, October 8, 2022. https://www.investopedia.com/ask/answers/100615/why-have-mutual-funds-become-so-popular.asp
2 “Mutual Funds Are Key to Building Wealth for Majority of US Households.” Investment Company Institute, October 31, 2022. https://www.ici.org/news-release/22-news-ownership
Disclosures:
This material is intended for informational/educational purposes only and should not be construed as tax, legal or investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Certain sections of this material may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results. Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption of any kind. Please consult with your financial professional and/or a legal or tax professional regarding your specific situation and before making any investing decisions.
Mutual Funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing in Mutual Funds. The prospectus, which contains this and other information about the investment company, can be obtained directly from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.
Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market. They are methods used to help manage investment risk.
Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.
