Safety of Mutual Funds
Mutual funds are a type of investment that many investors and experts consider relatively safe. A mutual fund is an investment vehicle in which investors can buy shares of ownership in a group of assets like stocks or bonds. The value of the mutual fund shares is based on the value of the assets that make up the fund. While they are safer than investing in an individual stock, risks still exist and careful considerations must be made. These funds provide diversification and are regulated closely by the Securities & Exchange Commission.
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Features
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Mutual fund investments involve buying shares of a large portfolio of securities. A fund manager is in charge of the portfolio and is the individual responsible for buying and selling securities. The group of investors in the fund are those who benefit from the capital appreciation of the underlying assets as well as from dividends or interest that is generated. You can invest in mutual funds with many different strategies and objectives, depending on your investment criteria.
Diversification
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One of the ways that mutual funds provide safety is through diversification. Most individual investors do not have the amount of money that it would take to buy enough securities to create a diversified portfolio. Mutual funds control a large amount of money, and the managers of the funds can afford to buy thousands of different securities. These fund managers can diversify the portfolio by purchasing different stocks, bonds or even shares of other mutual funds. This way, even if one of the underlying investments does not perform well, the portfolio can still generate returns.
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Regulation
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Mutual funds are regulated closely by the Securities & Exchange Commission. Each mutual fund company has to abide by these rules to be able to continue offering shares to the public. For example, mutual fund managers cannot use large amounts of leverage in the same way as hedge fund managers to amplify returns. As an investor, this means that you do not have to worry about the risk that comes with additional leverage. Since the SEC checks all the moves made by mutual fund managers, you can feel more confident that these moves are in your best interest.
Misconceptions
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Many investors mistakenly believe that there is some type of guarantee on a mutual fund investment. When you put money into a mutual fund, you could potentially lose the entire amount that you invest without any guarantees. This means that you should invest only money that you can afford to lose if things go badly. Another popular misconception is that the diversification prevents you from losing money. While diversification is a good long-term risk management strategy, it isn't foolproof. The fund manager could still build a portfolio of companies that perform poorly, and you could lose money.
Considerations
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Even though mutual funds are considered fairly safe compared to individual stocks, they still present some risks. If a fund performs poorly, by the time you add in the expense ratio that is charged you could end up losing money for the year. Careful research is necessary to minimize risk in mutual funds. By looking at the investment returns and the individual investment strategy of each fund, you can often increase the safety of your investment.
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