Strategic financial planning – How mutual funds work

Strategic financial planning – Mutual funds are popular, albeit often misunderstood, investment option. For the newer investor, mutual funds offer an alternative to risking precious money on a large number of different stocks or other investments.

Pooling of Funds Is a Key Component

Mutual fund accounts contain a wide diversity of securities, permitting individuals to join others in making smaller investments, while creating dollar pools large enough to make significant purchases of quality stocks, precious metals, bonds, or U.S. Government obligations. This pooling of money gives the fund the financial strength to make both wise and large purchases. Pooling also permits smaller or less sophisticated investors to enjoy the benefits of owning a small percentage of a wide variety of quality investments, helping them reach a goal of diversity.

Higher Quality Securities for Smaller Investment

People with limited investment funds are often unable to purchase acknowledged quality stocks or precious metals. Mutual funds, although targeted to specific types of investments, can purchase larger blocks of more expensive stocks for the group of fund investors. Instead of being forced to buy penny stocks or lower priced securities, mutual fund participants own shares of a strong group of investments.

The size of their share will be based on the amount of their money invested in the mutual fund. The more monies invested, the larger share of the fund owned by the investor. Gains, losses, and income will accrue to each participant in direct relation to their level of investment.

Participants Need Not Be Concerned About Purchases and Fund Management

The fund manager, highly trained and experienced in market trading techniques, maintains and controls the mix of investments in the fund so the participants need not be concerned with individual security trades. Investors should know the identities of the securities in their mutual fund, but need not worry about physically making trades.

Investors’ choices about which mutual funds to purchase will depend on a) the quality of the fund and its components, b) the quality of the fund manager, and c) the performance (earnings and growth) of the fund. They need not stress over the purchase or sale of individual securities, except as they relate to the overall composition of the mutual fund.

An Easier, Sometimes Safer Way to Invest and Diversify

Mutual funds, because of their diversity of securities, often outperform other investments in both the short- and long-term. However, as with all investments, there are no guarantees of high performance. In down economies, mutual funds typically suffer just as many individual stocks do. Yet, during the vagaries of normal stock market volatility, mutual funds can sometimes be safer options because of their diversity.

Pros and Cons of Mutual Fund Investing

Mutual funds can be an excellent investment strategy. They allow investors without large amounts of money to invest in the stock market, and can provide diversification.

With the many positives of mutual funds, there are still things that a prudent investor should consider before buying into this investing vehicle.

Types of Mutual Funds

Mutual funds can consist of many different types of investments. There are pure stock funds, bond funds, funds for precious metals and even funds of funds. A primary positive of mutual funds is the ability to own an investment in more than one company.

In the case of stock funds, a mutual fund may hold dozens or hundreds of stocks. To achieve this number of investments, a person buying individual stocks would have to purchase (with commissions) many stocks, and monitor them all for performance. Mutual funds have managers that take care of the administrative tasks.

Mutual fund types include managed funds, where managers select investments based on their judgment within the parameters of the fund, and index funds, where the investments are selected to equate to the components of a market index.

Negatives of Mutual Funds

Mutual funds are not insured. The price of a fund fluctuates and investors can lose money. Even bond funds can decline, since the fund buys and sells bonds before maturity.
Many funds perform worse than the overall market. Funds can perform poorly for a long time, and one year of outperforming the market does not guarantee future success.
Since some market benchmarks do not count income from dividends, funds that compare to them are really performing worse than it would seem, since the funds do include income from dividends. For instance, the Dow 30 does not reflect income from dividends.
Even funds that perform better than the benchmark can be negatively affected by a change in manager.
Diversification reduces risk, but also lowers the chance of a high return. Focusing on a few investments may result in large losses, but also holds the potential for large gains.
Some mutual funds still charge fees upon purchase, known as loads. It is now possible to find many no-load funds. Some funds also have additional 12-b-1 fees. It is important to review the prospectus carefully to be aware of any fees that are charged.
Some funds charge a redemption fee if the fund is held for a short time.
Almost all mutual funds include a management fee, which covers the cost of administrating the fund. Generally, index funds have lower management expenses than managed funds.
Mutual funds trade only after the close of the market. If there is a major movement in the market, a mutual fund investor will only be able to take advantage of price changes at the end of the day.
Mutual funds make distributions infrequently. Many funds make one distribution per year, and an investor can have tax implications related to transactions when they did not own the fund.

Owning a Mutual Fund amid Strategic financial planning

With many choices, and many fees and issues, mutual funds are not a simple investment but can be an important means to safeguard money while earning a competitive return.