Advantages and Disadvantages of Mutual Funds

Mutual funds are professionally managed companies or schemes that pool money from investors and invest it in stock markets, shares, derivative markets and other securities. The worldwide market for mutual funds is around $30 trillion. There are two types of mutual funds. These are open-ended mutual funds and close-ended mutual funds. Open-ended mutual funds sell the shares or units to a potential investor either in retail or in bulk. There is no restriction on the number being sold. Close-ended mutual funds have a limited number of shares on offer. Mutual funds have a varied interest in different securities encompassing various sectors. These securities yield dividends which are their primary source of earnings. They also gain by the redemption of shares by investors at a lesser price than the net asset values of the investment (NAV's).

Advantages of Mutual Funds

Professional Management: Mutual funds give a small investor a chance to invest a low amount in a professional manner. It is not feasible for small investments to be managed professionally, on an individual level, because of low capital and low returns for the managing company. Once you decide on a mutual fund to take care of your investment, all these charges can be avoided. You needn't be an expert in trading or market analysis for making an investment. A professional fund manager make decisions on behalf of every small investor who put in money through the firm, thus saving valuable time and effort.

Diversification: A good investment practice involves diversifying the amount in different stocks or bonds. It provides the option to hold a number of securities and reduce the risk of losing money, which is not subject to the volatility of a single stock.

Lower transaction costs: If you want to make an individual investment, it would involve a large transaction cost. On the other hand, a mutual fund involves a large amount of capital to be traded. Therefore, it bears a small transaction cost which eventually translates into a small transaction fee to be paid by an investor.

Liquidity: Mutual funds allow the liquefying of assets within a short period. Close-end funds may trade below or above the Net Asset Values, in which case, the investment recovered depends on the NAV of the security invested into. But the entire investment can be regained in two business days for an open-ended mutual fund.

Low initial costs and service: No-load mutual funds, which are a part of open-ended mutual funds, do not require transaction costs. An open-ended fund can be bought or sold with no premium or sale charge associated with it. Any doubt or clarification regarding the nature of your investments, can be immediately sought from a mutual funds company along with other professional services like software aided portfolio management.

Disadvantages of Mutual Funds
Following are some of the disadvantages of mutual funds.

High costs and risks: Mutual funds require a detailed study of the investment options as the fee charged by the management firm can be quite high. Mutual funds are subjected to market risks or asset risks. If the investment is not sufficiently diversified, it may involve huge losses.

Tax issues: Although, the returns on investments are quite high, a mutual fund cannot guarantee lower tax bills. The tax amounts are usually high, especially in case of short-term gains. Moreover, it is the fund manager who handles these issues and you cannot dictate terms on the amount of tax to be paid.

Investor issues and company profile: In case of repeated investments by new entrants, the value of shares owned by current or existing investor decreases significantly. Also, a mutual fund requires a deep and long term analysis of the amount of investment and its potential investment areas. If the company fund managers are changing regularly, it may adversely affect the returns on your investment. A mutual fund organization is, however, characterized by frequent changes in jobs and positions.

Thus, before deciding on a mutual fund investment, both the advantages and disadvantages have to be considered. If the advantages exceed the disadvantages, only then is it advisable to go through with the investment. Still, it is always advisable to do a bit of research yourself, before investing.