Regardless of whether you follow stock market performance, you likely know that some of the most popular companies also have some of the most expensive stocks trading on the stock market. Additionally, if you’re not a member of the finance industry, how do you take advantage of the stock market for your own investments, if you don’t know what to invest in or how to make those decisions?
One investment product that makes this task easier is a mutual fund.
Think of a mutual fund as an investment product that allows you to invest in a basket of investment instruments on an incremental basis. Instead of spending a $1000 to invest in one stock or bond, you can invest in a mutual fund and use that same $1000 to purchase a piece of several stocks or bonds in a basket of such investment instruments. You and other investors pool your money together to purchase the basket of financial instruments to participate in the stock market and benefit from the potential growth of those financial instruments.
Benefits of Mutual Funds
Investing in a mutual fund, provides the following benefits:
- Reduces the learning curve involved in picking investments. Mutual fund managers with the appropriate expertise determine what stocks the mutual fund investments in.
- Enables you to have your investment managed by professionals managing the fund.
- Systematic investment strategy in that the investment instruments the mutual fund invests in have complementary investment characteristics that support growth such as being in a given business sector such as retail or technology or being classified as a particular business type such as a mature or emerging growth company.
- Provides risk diversification through the investment of different companies that may achieve different performance outcomes. If one company in the fund performs poorly, the high performance of another company in the fund can offset the impact of that poor performing company.
- Spreads the cost of investing across multiple investors making investing more affordable.
Challenges of Mutual Funds
No investment instrument is without its challenges. What follows are some challenges to investing in mutual funds:
- Your return is dependent on the effectiveness and expertise of the mutual fund manager.
- Mutual funds can have significant administration fees reducing your overall return.
- You have no control over the specific investment instrument a mutual fund invests in.
- You must wait until market close to liquidate or invest in mutual funds.
- A portion of your mutual fund investment is generally held in reserve to cover redemptions.
- You may be subject to a lock-in clause where a redemption fee is assessed for liquidating your shares early.
If you’re seeking a long-term investment vehicle that can take the headache out of choosing the appropriate investment instruments to invest in while reducing costs, mutual funds might be just the investment vehicle your portfolio needs.