Continuing our discussion of mutual funds, let’s review their advantages. Investing in mutual funds is easier, less risky, takes less time, and costs less cash than investing in individual stocks or bonds.
Diversification – Investing in mutual funds is the easiest way to diversify your investments among a broad range of investments such as stocks and bonds. It is much less risky than owning a few individual stocks. If one of your few individual stocks crashes, it will damage your portfolio much more than if one stock in a mutual fund that owns 20 or more stocks. So investing in a mutual fund gives you instant diversification that lessens the risk to your portfolio. You can further diversify your risks with the types and number of mutual funds you invest in which we will review more thoroughly later.
Professional management – Since most of us don’t have the time or expertise to consistently pick individual stocks or bonds, it’s nice to turn to experts who hopefully can do better. Investing in mutual funds is one of the best and cheapest ways to get professional management for our investments.
Time savings – In addition to lacking the expertise, many of us lack the time to fully research many individual stocks as well as monitor their continued performance. Picking a diversified mutual fund is much easier in less time.
Affordability – You frequently can invest for a small amount of money, both for your initial investment and additional, future investments. Different funds set different requirements. Investors frequently buy stocks in “lots” of 100 shares that can cost thousands of dollars and it costs even more to diversify properly among many stocks and bonds. However, many funds will let you invest in a broad based mutual fund for as little as a $1000, and some require even less.
Systematic investments – Many funds make it easy to regularly invest small amounts in existing mutual fund accounts. You can setup automatic transfers of set amounts from your paycheck or bank account each pay period or month to buy more shares. This is a great way to follow one of our basic financial principles to put your savings on autopilot. It also has the advantage of following an investing method called “dollar cost averaging” in which your systematic, set amount automatically buys more shares when the price is low and fewer shares when the price is high which averages out the cost of each share.
This is a great way to save for practically any goal, not just retirement or college. Let me use this opportunity to throw in an example of the power of compound interest. Investing just $150 automatically, every month returning 8% would give you $27,625 at the end of ten years and $88,942 after 20.
Liquidity – Mutual funds are easy to buy and sell thru your stock broker, financial advisor, or directly from fund companies, but you also want some confidence that the price hasn’t dropped a lot since your purchase. Therefore, tailor your investment to the type of mutual fund best suited for your time horizon for needing your money back: money market funds for absolute safety in the short run, the appropriate bond funds for medium term risk and time horizon, and stock funds for long term savings.
Services – Many mutual fund companies offer services such as dividend re-investment plans, check writing, telephone and web switching between family funds, regular account and tax statements, and systematic deposits and withdrawals.