Money Talks, So Should You

Q&A: What are the pros and cons of mutual funds?

Tracy St. John
by Tracy St. John, The Garrett Network  (@FinancialAvenue)

My first job after college was working for a mutual fund company. Unfortunately, I was answering questions with a science and psychology degree. 

Now, as an experienced financial planner knowledgeable about the pros and cons of mutuals, I can provide more detailed help.

READ: Here are ways to find the best mutual funds

PROS:

Availability  

  • Most people do not have millions or even thousands to invest.
  • Mutual funds allow the average person to purchase a wide variety of securities at affordable prices.

Low Initial Investment

  • Many mutual funds have an initial investment requirement of $2,000 or $3,000.   
  • This can be even lower if establishing an Individual Retirement Account (IRA) or Roth IRA and set up automatic purchases.   

Diversification

  • A one stock mutual fund, for example, could hold 30 to over 500 stocks depending on the type of fund.
  • It’s a good way to buy a variety of stocks for potentially lower cost.

Selection

  • Mutual funds exist for most investment purposes like municipal bonds only, treasuries only or only large or international stocks.   
  • You can even buy mutual funds that provide a mixture of bonds and stocks.

Liquidity

  • Mutual funds offer great convenience, in most cases, in the ability to request a distribution of funds.
  • There are normally a few days for settlement, then funds can be received quickly whereas many other types of investments have limits and timeframes for trading and selling.

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I am a big believer in mutual funds and all that they have to offer, but for those with limited knowledge trying to figure out whether to purchase a mutual fund, there are some cons.

CONS:

Fees

  • Before purchasing, learn what share class is best for you because share class determines the fee or expense.  Most but not all mutual funds have a share class.
  • All mutual funds have an expense ratio — expressed as a percent of your total balance. For example, if an expense ratio is 1.12 percent, and you invested $5,000, your annual fee on a $5,000 balance would be $56.

Not always easy to compare

  • It can be difficult to compare funds that you think are similar.
  • Maybe two funds buy large companies, but one has a conservative approach and one is aggressive.   
  • As another example, some large company mutual funds only buy the “mega” companies with values of $30 billion and up; whereas, other large company funds focus on $10 to $30 billion.

Too Many Choices

  • Too much to choose from can become overwhelming.   
  • It’s best to have a general idea of what you want to invest in, and look only in those mutual fund categories.      

READ: What is behavioral economics?

A great place to learn more about mutual funds is the Mutual Fund Education Alliance.  

Yahoo also has a great resource that pulls basic mutual fund education from difference resources and lists them for you.

 

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Tracy St. John is the founder of Financial Avenues, LLC, a Fee-Only financial planning and investment advisory firm. She obtained her Masters Degree in Family Financial Planning as well as a Certificate in Personal Financial Planning through Kansas State University.