The Basics of Mutual Funds - Part 2: Major Benefits

Part 2: Major Benefits

Now that you know a little more about the origin of mutual funds (from Part 1 of this article series), we'll now look at some of the reasons why so many people choose these investment vehicles. Mutual funds are the primary means by which most investors in the United States purchase securities, especially in the stock markets. Whether novice or experienced, young or not-so-young, most individuals are attracted to these funds for four major reasons: diversification, convenience, professional management, and lower transaction costs.

Diversification offers protection against the danger of placing all of your eggs in one basket; in other words, putting too much of your money in any one company's securities. A mutual fund's investment portfolio generally consists of stocks, bonds, or both from different companies, usually in many different industries or business sectors, inherently neutralizing this risk. As a result, your money is shielded to some degree against the price decline of any one company or business sector. However, diversification does not ensure that the value of your investment won't drop at all. If the overall market declines sharply, then the value of any mutual fund -- no matter how well diversified it is -- will suffer as well.

In a number of ways, financial institutions have made mutual fund investing as convenient as one-stop shopping. Larger mutual fund companies routinely offer investors a wide variety of funds that have different objectives and which concentrate on different industries, markets, or types of securities. They also provide an increasingly broad array of customer services. Automatic investment plans, online purchases and redemptions, automatic dividend and capital gains reinvestment, and asset allocation models are just a few of the available services provided by these companies. The investor is thereby afforded a great deal of flexibility. Fierce competition among providers has forced funds to make it easy to implement investment decisions, track investment performance, and keep accurate records for tax-reporting purposes.

Professional management is another key benefit of mutual fund investing. The specific stocks or bonds in which the fund invests its shareholders' money are carefully selected by a professional portfolio manager or investment adviser. This may be a single person or a management team. Most of these individuals have an advanced degree and have taken additional courses to achieve the Certified Financial Analyst (CFA) designation. New graduates often complete an internship under the guidance of a more experienced or senior portfolio manager before being given primary responsibility for a particular fund. In addition, the fund usually employs or contracts researchers, investment analysts, and strategists to provide the manager with detailed information, insights, and interpretations that may be important when choosing individual stocks and bonds to fulfill the fund's objectives.

When compared to buying individual stocks and bonds to build a diversified portfolio, the lower costs associated with investing in these instruments through mutual funds are evident. A fund's administrative, operations, and trading expenses are spread over and shared by all of its shareholders, which could literally be thousands of individual investors. Transactions costs per person, therefore, for every dollar invested are greatly minimized.

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