What Is A Mutual Fund? Deciding If They Are Right For You

culled from:phroogal.com

Today, you have an almost unlimited number of investment options to choose from, so you’re probably wondering what investment caters to your needs. A mutual fund is a very popular type of investment, and there is a chance that it could be just what you’re looking for.

To decide if a mutual fund is right for you, it’s important to understand how it works. At its core, a mutual fund is a pool of money. Depending on the size of the fund, hundreds or even thousands of investors pool their money together.

A mutual fund consists of real estate, bonds, stocks and other securities. Everyone who has money invested in the fund gets a piece of the financial pie. Certain companies manage mutual funds for the investors.

Why Use A Mutual Fund?

One of the major reasons why many investors choose to invest in mutual funds is because the funds provide diverse investment opportunities.

Put simply, a mutual fund gives investors the ability to invest in cash, bonds, stocks and other securities while never requiring investors to make separate trades or purchases. To build a portfolio that has a similar level of diversification, an investor would need $100,000 or more.

A mutual fund provides the same level of diversification for far less money. An individual investor can obtain great diversification with about $1,000.

The Pros and Cons of Mutual Funds

There are several pros and cons of choosing to invest in mutual funds. Since these funds have become extremely popular, they’ve given investors the ability to participate in the stock market in a very special way. Before mutual funds, individual investors couldn’t achieve the same benefits.

In the year 2000, the stock market crashed, but an interesting fact is that roughly half of all American households owned some number of stocks, which were obtained through mutual funds. By 2004, mutual funds accounted for roughly eight trillion dollars in investments.

Most mutual funds focus on stocks. Investors who choose mutual funds have access to growth funds, index funds and more. Mutual funds provide investors with countless investment opportunities, which aren’t affordable to the individual investor.

A large number of investors have become aware of mutual funds because of participation in retirement programs such as the 401(k). Some of the benefits of mutual funds are investment size, professional management, diversification and convenience.

An average investor can use a mutual fund to buy investments that they wouldn’t be able to manage without professional help. By owning thousands of different securities, mutual funds provide diversification. A mutual fund is managed by industry professionals.

An additional benefit is the investment size available to investors. Even if an individual has virtually no investment experience, he or she can invest big or small amounts of money in a mutual fund.

Is It Right For You?

It’s true that mutual funds have many benefits to offer, but they’re not exempt from risk. One of the downsides is fees. An average mutual fund can be quite expensive to manage, so investors are charged sales commissions, also known as loads.

Investors must also pay annual fees, whether the fund is performing well or not. Another downside is that mutual funds must distribute their capital gains to shareholders, and it doesn’t matter how long the shares have been owned.

One more problem with mutual funds is something called phantom gains. Put simply, a mutual fund makes it possible for investors to lose money on investments and still owe taxes on the investments. If you decide to invest in a mutual fund, it’s important to compare expense ratios.

Also known as the TER, the expense ratio consists of the fund expenses and fees, which are divided by the average net assets. If a fund has a high expense ratio, then it reduces the amount of money you can make from the fund.

So weigh the pros and cons and see if a mutual fund is right for you. Used wisely, mutual funds can be a good investment, especially if you also diversify with other types of investments such as retirement funds, annuities and CDs (certificates of deposit).