Best Mutual Funds Explained
All you need to know about mutual funds, including the risks, rewards and terms  

Best Mutual Funds - Advantages & Disadvantages

best mutual fundsAs with most things in life, and certainly in the world of investing, there are always advantages and disadvantages and this is certainly true of mutual funds where the word "best" is a hard term to define. What's best for one, is poor for another, and every decision will be based on personal circumstances and personal preferences, whether this is risk, investment objectives or simply your personal view of the world. Mutual funds are no different - they are far from perfect, and indeed many would argue that they are worse than that, having been thinly veiled in secrecy and with some dubious financial practices being commonplace. However I believe they  have a place in the investing portfolio, so let's look at the advantages and disadvantages to provide a more balanced view.

Best Mutual Funds - Advantages

In my view the primary advantages of investing in mutual funds are as follows. First they provide a way for the smaller investor to spread the risks by diversification across the market, which would otherwise be impossible. For example suppose you had only $500 or perhaps $1000 to invest, it would be almost impossible to buy stocks, bonds or treasury bills and still spread the risk. A blue chip stock in the DOW 30 such as GE is currently trading around $26 so buying 20 shares would use up all your capital. Similarly, McDonalds at $57 per share would only allow you to buy 9 shares. So having invested $1000 we would end up with 20 GE shares and 9 McDonalds - hardly diversified and certainly very risky. Now the alternative might be to look for lower value stocks such as Goodyear Tyre currently trading around $18, but again even with stocks at this level you may only end up holding 3 or 4 companies. Now if you plan to invest this amount on a regular basis then this becomes a different matter entirely, as you would be building up your own diversified portfolio over time. So if you are investing small amounts regularly then you can diversify over time as you build you portfolio, if it is simply a one off investment of a relatively small sum, then mutual funds provide a good ( not necessarily the best ) solution to the problem.

Now the other advantages of mutual funds that are often mentioned are professional management of your money, economies of scale ( i.e. reduced trading costs to you and me ) and liquidity. Now my own view ( in case you hadn't already guessed ) is that I try to teach people to take responsibility for their money and their investment decisions, and to be blunt, if you have the time to learn about investing and trading, there is no reason that your investment should not perform as well, and probably better then your average fund manager - after all it's your money and who else is going to worry about it as much as you! If they were that good they would be working for themselves! I fully accept that many people have neither the time or the interest to learn, which is fine, but I just thought I would make the point. I have a whole site dedicated to the basics of trading and investing ( and it's all free!) if you are interested. Remember that you are paying for the privilege of having your money managed for you through the operating expenses of the fund.

Finally, on the advantages of economies of scale and liquidity. If I told you I trade using Interactive Brokers an online broker who charge $1 per trade to buy or sell  100 US shares, then I would suggest that this is competitive and tends to undermine this argument ( on mutual funds they charge $14.95 per transaction which again is very competitive)! With regard to liquidity, in stocks and bonds these can be bought and sold with the click of a mouse. Again I accept that you must have an online broker to do this, which of course is not for everyone, but I thought I would just counter some of the main advantages often mentioned.

Best Mutual Funds - Disadvantages

On the negative side we really have four main disadvantages, namely costs, the lack of control of your investments, lack of transparency, and price uncertainty. Costs and lack control I have really touched on above - it is a personal decision for you - in my view your investments will probably perform better provided you follow the basic rules of investing and money management which I explain in full on my site, and you will have significantly lower costs. Lack of transparency has been an issue with mutual funds for some time both in terms of investors understanding the portfolio along with lack of clarity on the operating expenses. If you are going to buy mutual funds then you must do your homework and understand as much as possible about the proposed investments and costs, all of which should be provided in your prospectus, so please read them, and don't throw them in the bin like everyone else! Finally price uncertainty is only an issue if you need to have minute by minute data - I don't personally ( except in my fx trading ) but as funds are marked to the market at the end of the day, then you do have to wait for updates.

So, in summary in looking for the best mutual funds, there are advantages and disadvantages as you would expect. If you are happy to let someone else make the decisions for you, then mutual funds may be the best option, and certainly if you have only a small amount of capital to invest this is probably best for you. However, do consider the bigger picture and think about whether it would make more sense for you to invest for yourself  - it's fun and provided you follow my rules, your capital will be protected.

Now let's look at some of the best ( and worst ) ways to buy mutual funds.

Best Mutual Funds - next page