What are Mutual Funds?Mutual funds are great investment vehicles that give investors the chance to benefit from the diversity attained owning hundreds of stocks and bonds. Attempting to achieve diversity buying individual stocks not only takes money, it takes time. To do it right you would have to work full-time analyzing stocks and buying and selling at the right time. Fortunately, mutual funds provide a way to build a diversified portfolio without having to be a large investor or a professional stock trader. So, these types of investment are basically a bag or pool of money collected from a large number of investors. Each investor puts in a relatively small portion of money that a portfolio manager uses to invest in securities. The manager doesn't just invest in whatever he or she wants. Rather, there are guidelines established for the fund about what to invest in. The fund will have a benchmark that it must follow. The benchmark will determine the type of fund. For example, a fund could be created with the S & P 500 as the benchmark. In that case, the portfolio manager of the fund will invest in stocks of the S & P 500 on behalf of the people that invested in the fund. A different fund will have a different benchmark, maybe investing in municipal or treasury bonds.
Active vs. Passively Managed FundsSome funds are passively managed. This means that the stocks are held in positions that match as closely as possible the underlying benchmark. Since the stocks are held in proportion to the makeup of some index or market sector, the portfolio manager doesn't have to do much active work. When a fund is passively managed, it will have lower costs because of this reason. In contrast, an actively managed fund is one where the portfolio manager overweights securities that he thinks will outperform the benchmark and underweights securities he thinks will underperform. This type of active investing requires analysis of stocks and active trading of shares. The upside is that the mutual fund may actually outperform the underlying benchmark. On the other hand, the costs associated with an actively managed fund are higher, since you have to pay for a fund manager that is actively engaged in trying to make more money for the fund.
AdvantagesThe main advantage is that it provides small investors with a way to build a diversified portfolio. These funds tend to own a lot of stocks or bonds, and it would be difficult for an individual investor to own hundreds of stocks or a large number of bonds since that could require millions of dollars. With a mutual fund, however, a small investor can own part of the fund for a few thousand dollars and benefit from the diversity of the stocks and bonds that the fund invests in. Mutual funds give small investors the opportunity to spread risk and track major indexes like the Russell 2000 or S & P 500. Have a contribution to share about this topic?Do you have a great story about this? Share it! |