Nowadays mutual funds are an extremely popular way for people to invest their money. They are deemed to be low risk and useful long term investments but there are advantages and disadvantages to undertaking such an investment.
Firstly it is important to understand how mutual funds work. They are often sold by companies and can be bought in shares. When a collection of people buy shares in a mutual fund, the money from all the shareholders is invested in various forms such as bonds and stocks. Over time the investments made by the mutual fund should make a profit and this money is divided amongst the shareholders proportionately. Income from owning shares in a mutual fund can generally be earned by three different methods. As already mentioned, if the mutual fund makes profit on the bonds and stocks it has invested in, then this money will trickle down to the shareholders. Alternatively if a mutual fund sells securities that have made a profit they will pass some of this capital gain down to the shareholders. Lastly, shareholders can also opt to sell their shares if the mutual fund has increased in value.
There are some excellent advantages to investing in mutual funds and this is why so many people do invest. All the investment is handled by professional investors and analysts who can determine where best to buy bonds, stocks and securities. Attempting this yourself, as a non-professional investor will reveal the distinct advantages of using professionals. Another of the benefits to mutual funds is the concept of diversification. Diversification is one of the main selling points of mutual funds because it allows people to make investments in a number of areas with only a small amount of capital. Mutual funds diversify investments in order to reduce risk too. By investing in a number of areas, the mutual fund will minimize any potential losses and then cancel them out with potential gains from other investments. Diversification of this manner would not be possible for many people without mutual funds and it offers people a low risk method of investing in many areas.
Finally mutual funds also offer the opportunity for investors to turn their shares into cash at any moment and this is a massive advantage over other areas of investment.
As with any investment there are also disadvantages to mutual funds. One of the advantages mentioned already is also viewed as a disadvantage by some. Some argue that the professional management does not work in the shareholders behavior because regardless of the performance of the professionals, they will still get paid and they are prone to making misjudgments.
The diversification of mutual funds is also viewed by some to be a negative. This is because too much diversification can spread investment too thinly and this results in small profits and small losses simply cancelling one another out over time without making significant money. This is more commonly known as dilution.
Ultimately a mutual fund is a sensible way to invest money but there are some things to consider before taking the plunge.