Downsides to Stock Market Mutual Funds

Stock market mutual funds can outperform other types of investments in the long run; however, investing in these funds is not without risks.

No Insurance Coverage

Because stock market prices are volatile and fluctuations in value are normal, insurance companies do not cover stock market mutual funds. Since your investments are not insured, during economic downturns, you may lose money and be unable to get it back unless you keep your stocks and wait for the market to recover. If the market does not rebound in time and a company that issued some of the stocks goes bankrupt, you will be unlikely to recover the cost of that investment. The good news is that since mutual funds allow you to invest in a diversified portfolio, you may not actually go empty-handed in the end.

Diversification Lowers the Income Potentials

Although diversification can spread and reduce the risk, it can also lower your income potential. In the event that certain stocks in your portfolio do not perform well while the others do, you may still not earn much. The earnings you get from stocks that perform well will be offset by the losses you incur from poorly performing ones. Therefore, ultimately, you may earn only a little—or worse, you may even lose money.

Unstable Income

If you invest in common stocks, you are at the mercy of the market forces. There is no guarantee that an investment portfolio that raked in a lot of profits last year will perform well this year. Always remember that prices are driven by a number of factors, including market conditions, so when market conditions shift for the worse, your stocks may lose some of their value.

At the same time, if you invest in preferred stocks with fixed interest rates, you will not be able to enjoy income flexibility. Since the value-preferred stocks have limited potential to appreciate, you could get stuck with low-rate preferred stocks and end up losing money.

Fund Management Cost

Stock market mutual funds charge management fees to cover the cost of administration. Even if you did not earn money on your investment for the year, your fund manager may still charge you for managing your funds. Also, if you withdraw your investment after a short time, your fund manager may charge a redemption fee to cover administration costs.

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