Simply put, a mutual fund is a type of investment that brings together a collection of stocks, bonds, or other securities. This collection is known as a portfolio. Each share represents the investor’s ownership of the fund’s holdings and the income those holdings generate. Mutual funds generally make investors money either by way of dividends on stocks and interests on bonds, or a capital gain on the sale of securities. Mutual funds also allow you to receive a check for the distributions or simply reinvest the earning into more shares.What are the Benefits?
At face value, mutual funds have several benefits worth noting.
First and foremost, since a mutual fund is essentially a collection of securities, it is liquid, meaning you can sell it for cash at any time.
Mutual funds also brings with it the benefit of professional management. Small, inexperienced investors often favor this tool, since they have neither the time, nor the expertise to manage their own portfolios.
Additionally, a mutual fund allocates risk very well. Instead of placing “all your eggs in one basket”, or in this case one stock, investors can place one egg in 12 separate baskets that are all held by the same person (the mutual fund). If one basket drops, your losses won’t be as great.
Mutual funds are very easy to purchase. Most banks have their own mutual funds set up or companies like Scottrade allow investors to buy them themselves.
Initial investments in mutual funds are inexpensive. An investor can start one for a very low dollar amount, or subsequent monthly payments, or often both.
As is the case with most investments, there are detriments to every benefit.
To many investors, the idea of having someone monitoring your portfolio is simply relinquishing too much control. Experienced investors prefer a more hands-on approach to their accounts and often see the lack of control as unappealing.
While the startup of a mutual fund is inexpensive, there are often hidden fees associated with these funds. Remember, that person who is managing your portfolio 24/7 needs to be paid too, and while the commission may seem low (Let’s just say as low as 2%) remember, 2% off $1 million is still $20,000.
While the diversification of risk can be a good thing in some cases, it can also inhibit generating higher profits, in others. This is known as dilution. For example, let’s use the egg in the basket analogy once again. While placing one egg in 12 baskets ensures you won’t lose all 12 eggs (at least it’s less likely) if one basket suddenly starts to make double the amount of eggs in one of the baskets, you’d now only have 2 eggs in that basket instead of the 24 you would have had in the first scenario. This is a simplistic example, of course, but you can see why some investors would not favor this over diversification.
When a fund manager sells a security, capital gain tax is triggered, unless it is mitigated by way of a tax-deferred account like a ROTH IRA or a Traditional IRA.
If you, or someone you know has lost money as the result of a mutual fund investment, and you believe it is the product of financial malfeasance, please contact the securities attorneys at Fitapelli Kurta. Our firm handles cases on behalf of investors nationwide. All cases are taken on a contingency fee basis, so if you don’t win, we don’t win. Time is of the essence in these cases, so do not wait. Call now.