Mutual Funds: The Pros and the Cons

First thing first: What is a Mutual Fund?

A mutual fund is a strategy for investing that allows you to pool your money together with others to purchase a collection of stocks, bonds, or other securities. Typically, the fund is purchasing something that might be difficult or impossible for you to purchase on your own.

The collection of holdings that the fund, or company, purchases is called its portfolio. As an investor, you own a share of the fund. However, you do not own any of the portfolio. This is different; the individual stocks do not belong to you.

Now… let’s talk about some pros and cons of mutual funds.

Pros:

1. Mutual funds are convenient: You are doing a lot less of the research and work. Others do the “thinking,” and you are there to make money.
2. Mutual funds are diverse: By coming together with other investors, you are able to hold an assortment of holdings that you would be unable to purchase on your own. You are no longer limited by your own finances, and your personal opportunities soar.

3. The funds are professionally managed: Typically, there are a couple of professional managers and also a team of researchers leading the fund. People much more qualified and experienced are calling the shots.

4. They are fool-proof: By joining a mutual fund, you have the opportunity to invest any amount of money with very little experience or investing history. You don’t have to continually decide which stocks will be a good investment. After joining, you are able to sit back and relax.

Cons:

1. Mutual funds charge fees: Mutual funds are expensive to run, and therefore investors are often hit with high fees. There are often annual rates and sales commissions included in the funds.

2. Share prices are only calculated once a day: Unlike single stocks, you cannot check price changes of a mutual fund throughout the day. The price completely depends on the fund’s net asset value (NAV), which is determined by all the different holdings within the fund. This is only calculated once each day.

3. Shareholders are distributed Capital Gains: By law, mutual funds must distribute capital gains to investors. No matter how long you have been a part of the fund, the distributions are still taxed at the long-term rate. With single stocks, taxes on capital gains do not have to be paid until after you sell the stock and thus make profit. In mutual funds, you also have to pay taxes every single year on the fund’s capital gains.

4. Phantom Gains: Bummer alert- this is a pretty big con. In a mutual fund, you can actually lose money on an investment, but still owe taxes. Talk about back-tracking… This is common when mutual funds are doing poorly, and investors decide to sell. The fund may in return have to sell profitable investments in order to raise money to pay off the investors leaving. This creates capital gains, which are then distributed to all the investors.