Why Invest in Them

Mutual funds offer consumers several unique advantages that are difficult to duplicate in any other way. Because they hold a large basket of securities, each share of any fund represents a tiny portion of ownership in each of those securities in the same manner that a spoonful of a stew holds a bit of every ingredient that was stirred into the pot. Each fund share thus represents an entire portfolio of securities in one bite-sized security.

For example, a global large-cap growth fund may own stock in every single company in the Standard & Poor’s 500 Index plus large, established companies in several other countries around the globe to comprise total holdings of 1,000 stocks. Assuming that there are 50 million shares of the fund outstanding, each fund share represents ownership of 1/50 millionth of each stock in the portfolio.

The net effect of this is therefore that a completely uneducated, common-Joe investor can enjoy the same level of diversification as wealthy sophisticated investors who can create private portfolios requiring hundreds of thousands or even millions of dollars. They can also have their money managed by professional managers who may have 20 or more years of experience and carry credentials such as the Chartered Financial Analyst, a rigorous academic designation that takes at least 3 years to earn.

As mentioned previously, these managers will trade the securities in the fund to meet a specific objective, and they are paid and trained to make unbiased investment decisions based upon an established trading plan or strategy that is designed to meet that objective. They are not subject to the emotional bias that can creep into the decision making-process that plagues the majority of inexperienced investors who are making their own choices.

Cost Efficiency

There is a further stipulation to the benefit that investors reap from the diversification afforded by mutual funds. Investors are able to receive this benefit for the cost of purchasing a single share of one security, whereas the transaction costs that would be generated from creating a similar private portfolio would be exponentially higher.

If we build on the previous example and say that each share of the fund costs $5.50, then the shareholder can participate in ownership of 1,000 different securities for mere pennies compared to the commission cost that would be required to purchase even a single share of each of the stocks held by the fund, not even counting the cost of each share itself.

Of course, the exact cost that the shareholder pays will vary from one fund to another based upon the fund’s expense ratio and whether or not the fund assesses a sales charge upon either purchase or redemption (or both).

The Liquidity Factor

Another element of convenience found with mutual funds is the ability to purchase and redeem shares with relative ease. If the fund is an open-ended fund, then it will take three business days for the trade to settle when you buy and sell. If you need money by Friday, then you’ll have to sell your shares by Tuesday at the latest in order to get your money on time.

If you are holding a closed-end fund or Exchange-Traded Fund (ETF) that trade on the exchanges during market hours, then you can buy and sell them any time, although you will probably still have to wait for three business days (T+3) to get a check if you wish to actually withdraw the sale proceeds.

How Can They Help You?

There are several ways that mutual funds can help you to achieve your financial goals. If you just graduated from college and want to start saving for retirement, then you can open an IRA and start investing in long-term growth funds that have historically outpaced the rate of inflation. If you are looking for conservative income, then you can find one or more funds that invest in portfolios of government, municipal and corporate bonds, or perhaps an alternative such as preferred or utility stocks or senior secured loans.

There are mutual funds available to help you achieve virtually any type of investment objective, including some that can even move inversely with the markets for sophisticated contrarian investors.

The Bottom Line

Mutual funds offer several key benefits to investors of all stripes that cannot be easily matched by most other types of investments. Their liquidity, diversification and professional management make them ideal vehicles for achieving any type of investment objective, including growth, income and tax efficiency.