Mutual fund

A mutual fund provides an excellent opportunity for you to place your money with a professional investor and to capitalize on the power of pooling resources.  A mutual fund is a professionally managed portfolio of investments.  Individual investors, such as yourself, will buy shares of the mutual fund.  In turn, the portfolio manager will then select which investments to purchase and the quantity of each.  For the individual investor mutual funds hold a few benefits:

  1. Diversification - Buying stock in one company is extremely risk since you have "all your eggs in one basket".  A mutual fund is composed of many stocks, sometimes hundreds. By investing in a wide range of stocks you reduce the risk that your investment will be affected by the drop in one stock price.

  2. Professional management - Working with an independent wealth manager may be more expensive and time consuming than some people would like.  With a mutual fund you simply pick the fund you want to invest in and the fund manager takes care of the rest.

  3. Liquidity - In the world of investments liquidity is very important.  Imagine if you wanted to sell your investment, but there was no one willing to buy.  You might be stuck holding a losing position or unable to cash out after a large gain.  Mutual funds are usually very liquid so you can buy and sell shares without trouble.

A few drawbacks to mutual funds would include:

  1. Fees - Mutual funds do charge fees and you need to carefully read what fees they charge before investing.  Doing your due diligence is important as some mutual funds have higher fees than others.

  2. Trading Schedule - With stocks and ETFs you can buy or sell anytime that the market is open.  Mutual funds are only bought and sold at the end of the day.  So when you place an order it will not be executed right away.  Rather, it will be completed at the end of the trading day.

  3. Minimum Investments - With some mutual funds you are required to have a larger initial investment. Some funds require a few hundred dollars and others a few thousand dollars or more.

Fees

To cover the costs of the fund manager and other expenses mutual funds do charge fees. Here is a quick breakdown of the common fees to look for. Note: not all funds charge all of these fees.

  • ​12b-1 Fees: These fees are used to market and advertise the fund

  • Front End Load: A fee charged when you buy into the mutual fund.  Think of this as a fee for entrance to the club.

  • Back End Load: A fee charged when you sell your position in the mutual fund.  The opposite of a front end load.

By law, a mutual fund is required to disclose all of the possible fees you may be charged. You can view the fund prospectus for detailed information.  The prospectus is a long document that describes the fund in detail. It includes information on fees, how the fund is invested, past results and a history of the manager.  This is a great document to review before making any investments.

Another consideration to take into account is the fund's Portfolio Turnover Ratio.  With a mutual fund investment you will pay taxes on your capital gains at the end of the year. These capital gains are accrued when investments are sold for a profit.  If your mutual fund has a high turnover ratio that means they are buying and selling assets frequently. This could translate into higher fees for you come tax season.