What Are the Advantages of Mutual Funds? (2024)

Mutual funds offer a good alternative for investors who have limited time to watch the markets' ups and downs. They are investment pools that collect money from many investors and invest it in assets like stocks, bonds, a mix of both, or other securities. They are managed by professional advisors but owned by the investors. So, many investors chip in, and a fund manager calls the shots on what investments to buy for the group.

Most American households are invested in mutual funds. Why are they so popular? Below, we explain their advantages.

Key Takeaways

  • Mutual funds offer diversification or access to a wider variety of investments than an individual investor could afford to buy.
  • Investing with a group offers economies of scale, decreasing your costs.
  • Monthly contributions help your assets grow.
  • Funds are more liquid because they tend to be less volatile.
  • Investors get professional investment management services.

Diversification

One golden rule of investing for the newest and most experienced investors alike is diversifying your assets when possible. By putting money into investments that act differently in the same economic conditions, you cut the risk to your overall portfolio. For example,buying retail and industrial stocks reduces the impact on your portfolio of a poor quarter in one of those sectors. Stocks might go down when interest rates are up, but that means your bonds are likely to pay more in interest.

Before the first publicly available mutual funds began selling shares in the mid-1970s, you needed wealth or expertise to have a portfolio of stocks from different kinds of companies across the economy, plus bonds with varying maturity dates from several issuers. By purchasing mutual funds, you get that diversification instantly.

One caveat, however, is that you might not get adequate diversification by investing in a single mutual fund. Don't put all your money in a single sector-specific or industry-specific fund. An oil and energy mutual fund might spread your money over 50 companies, but if energy prices fall, your savings will suffer. Instead, look for a fund to spread your assets among several leading industries. You'll take advantage of an increase in one of them while avoiding a big hit if one sector has a rough year.

The most popular mutual funds are life cycle or target-date funds. These offer diversification beyond one specific industry or asset type and change their holdings toward less risky and more income-producing assets as the target date approaches.

Economies of Scale

The easiest way to understand economies of scale is to consider volume discounts. In many stores, the more of a product you buy, the less it costs. A dozen doughnuts is usually cheaper per doughnut than buying three. This also occurs with securities. If you buy one share of stock, the transaction fee will be the same as if you bought 1,000 shares. That's a hefty bite out of your investment in one share but a negligible nibble out of 1,000 shares. For the fund, they also save, generally, by having less staff per investor as their size increases, which should decrease your fee.

Fees vary widely. Most major fund managers offer no-load (commission-free) mutual funds, but you'll want to compare the expense ratio and any other costs that could eat into your savings over time.

Mutual funds use their trading volume to cut transaction costs for their investors. When you buy a mutual fund, you diversify without paying the 10 to 20 transaction fees that would give you a similarly diverse individual portfolio. And that's only the initial purchase fees. Add the transaction fees for every modification to your portfolio, and the costs go up.

Divisibility

Most people investing in mutual funds do so each paycheck through their employer's 401(k) plan. But you don't need an automatic payroll deduction to sock away a regular round sum every month. Each time you do, you get another tiny bite of many assets. Stock-pickers, by contrast, might get one or two shares of stock with an odd number of dollars left over. Or the investor can save up for many months to get one share of Chipolte Mexican Grill (CMG).

These periodic investments in a mutual fund also allow you to take advantage of the benefits of dollar-cost averaging. This strategy cushions a portfolio from the impact of price volatility. You simply put the same amount in whatever the market is doing, which should be to your benefit over the long term.

So, rather than waiting until you have enough money to buy higher-cost investments, you can invest immediately in a mutual fund. This choice provides an additional advantage: liquidity.

Liquidity

An investor who is hit with a financial emergency might have to sell in a hurry. It can be disastrous if the assets have taken a hit at the wrong moment. This tends to be less of a problem with mutual funds, which swing in value less wildly because of their diversification.

Watch out for any fees associated with selling, including back-end load fees, which are percentages deducted from your total when you sell the fund. Also, unlike stocks and exchange-traded funds, mutual funds trade only once daily after the fund's net asset value is calculated.

Professional Management

When you buy a mutual fund, you also choose a professional money manager. This manager makes the decisions on how to invest your money based on extensive research and an overall strategy for making money. Only you can decide whether you are more comfortable with that than making the decisions on your own.

Convenience

Investing in a mutual fund is relatively simple, especially for those who can do so through payroll deduction. Unlike buying individual stocks or bonds, which require thorough research and figuring out the right brokerage platforms, mutual funds can be purchased directly through investment firms, financial advisors, or retirement accounts.

Another reason they are convenient is because they have low minimum investment requirements. Some mutual funds let investors buy in with no minimum at all (especially if it's done through your employer), and this means that even $5, $10, or $100 can get you invested. Thus, you can start investing with a smaller amount of money compared with buying individual stocks, which can cost significantly more per share. This flexibility is ideal for new investors who are just starting out or those who want to invest a smaller part of their savings regularly.

Employer Matching

About 65% of those invested in mutual funds do so through their employer. This provides more than just dollar-cost averaging through payroll deductions. Most employers offer some form of matching, from $0.50 to $1.00 for every buck you put in your 401(k). Not saving this way, then, leaves this money on the table, Peter Lazaroff, financial advisor and chief investment officer at Plancorp, told us.

He noted it's risk-free money—the match can double your stake before you get any returns from the mutual fund investment. Lazaroff suggests you try to max out on whatever match your employer provides. “You can still chip away at debt and put away small amounts in an emergency fund if necessary. But securing that employer match is crucial,” he said.

Fidelity reports that more than four out of five of those coming to them through their employers receive some form of matching. Vanguard says it's even higher for its plans, with about 95% of employers matching their employees and almost half providing non-matching funds—a certain amount of money whatever you put in.

The point is that it's worth checking how to maximize your investment by contributing the most you can while your employer matches you. The median match, by the way, is up to 4.5% of your salary.

What Are the Risks of Mutual Funds?

Mutual funds aren't guaranteed to rise in value. They can lose money along with the market, and their performance depends on the manager's skill. Always consider these risks before investing.

Can I Easily Sell My Shares In a Mutual Fund if I Need the Money?

Certain funds charge a fee if you sell your shares in a mutual fund. This fee is known as back-end load. It's a percentage of the value of the fund’s shares and is paid by investors when selling mutual fund shares. Additionally, investors who want to sell their shares before a specific deadline (usually within the first few months you're with a mutual fund) are subject to early redemption fees. There are also tax implications since whatever you take out will count as income that year.

Since Mutual Funds Are Professionally Managed, Can I expect Them To Outperform the Market?

Professional management doesn't guarantee market-beating returns, and past success isn't necessarily indicative of future results. The fund's performance depends on the specific holdings, the manager's skill, and, more generally, the market.

The Bottom Line

If you decide to forego stock-picking and go with a mutual fund, you still have one last investment decision to make: which fund to buy. There are almost 3,000 of them.

Mutual funds offer several advantages, making them the most popular choice among mainstream American investors. One of the primary benefits is diversification, which reduces the risk of loss by spreading investments across a wide range of assets.

Mutual funds also provide professional management, allowing you to leverage the expertise of fund managers who make investment decisions based on their research and analysis. Additionally, mutual funds offer convenience and accessibility. Another advantage is liquidity, as investors can typically buy and sell shares of mutual funds relatively quickly. This flexibility helps you tailor your approach to meet your financial goals.

What Are the Advantages of Mutual Funds? (2024)

FAQs

What are the benefits of a mutual fund? ›

Mutual funds give you an efficient way to diversify your portfolio, without having to select individual stocks or bonds. They cover most major asset classes and sectors.

What are the advantages and disadvantages of mutual funds? ›

To conclude, Mutual Funds offer numerous benefits, including professional management, diversification, liquidity, and tax efficiency. However, it's crucial to consider factors like costs, exit loads, over-diversification, and volatility before investing in them.

What are the advantages of mutual funds quizlet? ›

Mutual funds offer many benefits. Some of those benefits include: the ability to invest with small amounts of money, diversification, professional management, low transaction costs, tax benefits, and the ability to reduce administrative functions.

What is the main advantage of a mutual fund over a stock? ›

The primary reasons why an individual may choose to buy mutual funds instead of individual stocks are diversification, convenience, and lower costs.

Is mutual fund good or bad? ›

Mutual fund investments when used right can lead to good returns, keeping risk at a minimum, especially when compared with individual stocks or bonds. These are especially great for people who are not experts in stock market dynamics as these are run by experienced fund managers.

What are the risks of mutual funds? ›

All funds carry some level of risk. With mutual funds, you may lose some or all of the money you invest because the securities held by a fund can go down in value. Dividends or interest payments may also change as market conditions change.

What is downside in mutual fund? ›

Investors assume a level of risk that a security increases or decreases in value. Downside risk represents the worst-case scenario and may be precipitated by a market or economic event that causes a decline in the security's price in the short term.

What is one downside of a mutual fund? ›

Disadvantages include high fees, tax inefficiency, poor trade execution, and the potential for management abuses.

What is the real rate of return in mutual funds? ›

Real rate of return is the annual rate of return taken into consideration after taxes and inflation. However, a rate of return that does not consist of taxes or inflation is referred to as a nominal rate. Likewise, a rate of return that includes taxes or inflation in its calculation is the real rate.

Which is one major advantage of mutual funds how the market works? ›

Advantages To Using Mutual Funds

Mutual funds have historically been an important part of retirement planning; since the funds are professionally managed, they do not require as frequent attention compared to a portfolio of stocks you actively pick, buy, and sell.

What is the most important advantage of a money market mutual fund? ›

Money market mutual funds provide investors with liquidity. That's because these funds are invested in securities that mature in short periods of time and can be liquidated for cash.

How often can a mutual fund be bought or sold? ›

Unlike stocks and ETFs, mutual funds trade only once per day, after the markets close at 4 p.m. ET. If you enter a trade to buy or sell shares of a mutual fund, your trade will be executed at the next available net asset value, which is calculated after the market closes and typically posted by 6 p.m. ET.

What is the primary advantage of a mutual fund? ›

One of the primary benefits is diversification, which reduces the risk of loss by spreading investments across a wide range of assets.

What are mutual fund benefits? ›

Investing in mutual funds offers several benefits such as professional management, diversification, liquidity, low cost, tax benefits, affordability, safety, and transparency. Can you lose money in mutual funds? Yes, mutual funds are subject to market risks and hence there could be a possible loss of principal.

What is the best mutual fund? ›

5 Best Mutual Funds to Buy Now
Mutual FundAssets Under ManagementExpense Ratio
Vanguard Wellington Fund (ticker: VWELX)$111.7 billion0.26%
Vanguard Total Stock Market Index Fund (VTSAX)$1.6 trillion0.04%
Fidelity 500 Index (FXAIX)$512.4 billion0.015%
Fidelity ZERO International Index (FZILX)$4 billion0%
1 more row

How do you make money from a mutual fund? ›

3. How investors can make money with mutual funds
  1. Appreciation in the fund's NAV, which happens if the fund's investments increase in price while you own the fund.
  2. Income earned from dividends on stocks or interest on bonds.
  3. Capital gains or profits incurred when the fund sells investments that have increased in price.

Are mutual funds better than stocks? ›

Mutual funds or stocks—which one offers more security? Mutual funds typically offer more security compared to individual stocks because they spread investments across various assets, reducing the impact of market fluctuations. However, the level of security depends on the specific mutual fund or stock chosen.

Are mutual funds high or low risk? ›

Because most mutual funds offer a level of built-in diversification, they're typically considered a lower risk investment. However, as with all investments, there are still risks involved, and mutual fund returns aren't guaranteed.

What is high risk in mutual fund? ›

High-risk mutual funds are those that invest in stocks or equity that have a higher risk of losing value. These funds are also known as equity funds or growth funds. They are designed for investors who are willing to take on more risk in exchange for the potential of higher returns.

Top Articles
Latest Posts
Article information

Author: Duane Harber

Last Updated:

Views: 5818

Rating: 4 / 5 (71 voted)

Reviews: 94% of readers found this page helpful

Author information

Name: Duane Harber

Birthday: 1999-10-17

Address: Apt. 404 9899 Magnolia Roads, Port Royceville, ID 78186

Phone: +186911129794335

Job: Human Hospitality Planner

Hobby: Listening to music, Orienteering, Knapping, Dance, Mountain biking, Fishing, Pottery

Introduction: My name is Duane Harber, I am a modern, clever, handsome, fair, agreeable, inexpensive, beautiful person who loves writing and wants to share my knowledge and understanding with you.