Advantages and Disadvantages of Investing in Mutual Funds

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Investing in a mutual fund is an alternative to investing in individual stocks, with the investor buying into a fund that has professional managers who use the pooled resources of many investors to purchase stock in multiple companies. The growth of a mutual fund depends on the performance of the stocks it includes, as well as when the managers buy and sell shares. Mutual funds are commonly used to save for retirement or diversify a portfolio.

Convenience and Control

One of the major advantages of a mutual fund is convenience. After choosing a mutual fund to invest in, the investor does not have to actively manage the account or even follow the progress of the stocks in the fund. Instead, professional managers with experience in buying and selling stocks keep track of market trends and make the decision to buy or sell for the fund's investors.

To some investors, this convenience can seem like a lack of control. An individual investor has no say in the day-to-day management of the fund, despite having money tied up in it. This makes mutual funds a better option for investors with less of a hands-on approach to investing.

Diversification

Mutual funds include stocks from many different companies. This type of diversification is beyond all but the wealthiest private investors. It spreads out the investors' risk evenly among all of the companies in the fund, so that even if one of the stocks falls sharply, other stocks in the fund will help minimize the fund's losses. Mutual funds also use each stock they contain as a potential source of gains, with fund managers able to invest more heavily in companies poised for growth by drawing money out of underperforming stocks or those that appear to have reached peak value.

Risk

The diversification of a mutual fund makes it less risky than buying an individual stock, but mutual funds are still not the safest investment option. Government bonds offer a nearly risk-free option, but with limited room for growth. Different mutual funds have managers who use their own strategies, some more aggressive and risky than others. An investor should always examine a mutual fund's past performance before choosing to invest.

Fees

Mutual fund managers charge fees that can reduce the profitability of investing in mutual funds or amplify the losses. These include load charges and back-end charges, which managers charge when they buy or sell shares, respectively.

Choice of Investments

Some mutual funds use stocks from throughout the stock market. Others rely on stocks in a single industry or sector of the economy. For example, investors can choose to invest in a technology mutual fund that only buys stock in tech companies. Mutual funds exist for nearly every type of industry, giving investors a choice of what part of the economy to invest in. Ethical concerns also drive mutual funds, like those that only invest in companies with strong environmental records and progressive policies.

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