What are the perceived advantages in using mutual funds to create a well-diversified investment portfolio? Fund companies usually claim: easy diversification; painless investing; high liquidity; low-cost; professional asset management. A look at these potential advantages of investing in mutual funds.
All that and more in Episode 30 on the Wilson Wealth Management YouTube channel.
“How can mutual funds provide my portfolio with ‘easy’ diversification?”
There are a vast number of mutual funds, covering almost every asset class and subclass. And every style or type of investing you desire.
Many mutual funds are well-diversified within their asset class or subclass.
If you want total ease, there are balanced or target date mutual funds that may allow you to invest all your capital in one, single investment. Investing cannot be more simple than that.
Mutual funds may provide access to investments that smaller investors cannot access on their own.
Perhaps you want venture capital in your portfolio. You may require a significant cash investment to access some venture capital investments. Many of which may have relatively poor liquidity and necessitate a 12-14 year investment period. Factors that may exclude a venture capital investment for many smaller investors. However, a venture capital fund may allow for smaller capital contributions and more consistent cash flows. Making this more attractive for smaller contributors.
“Why is investing in mutual funds considered ‘painless’?”
Mutual funds can be very cost-effective and efficient to buy and sell.
Initial purchases tend to have reasonable minimums. Subsequent investments are often at even lower dollar amounts. As well, there are normally direct deposit systems and dividend reinvestment plans. Both of which facilitate future purchase patterns.
Fund companies track and disclose fund holdings and performance on a continuous basis. Allowing for investors to easily monitor their investments. Fund companies also produce tax data which simplifies the investor’s personal tax preparation at year end.
Painless investing is indeed a big selling point for mutual funds. And a large differentiating factor between fund companies in trying to attract new investors. So, yes, mutual fund investing tends to be simple and straightforward.
“How can mutual funds help improve investor ‘liquidity’?”
Common mutual funds can normally be bought and sold on a daily basis. Based on the fund portfolio’s closing net-asset-value. This results in decent liquidity within larger, more established mutual funds. And for investors with relatively low amounts of money in a specific fund.
Note that some mutual funds may allow for purchases and redemptions on a lesser basis. The less frequent the ability to trade, the more likely you will face liquidity concerns.
“Why are mutual funds considered ‘low-cost’ investments?”
Attempting proper diversification via individual, non-diversified assets is typically neither “easy” nor “painless”. It also tends to be relatively expensive.
In transaction costs, to buy or sell multiple investments. In paperwork cost, to monitor the portfolio and deal with tax details. Or, in fees to delegate your portfolio management and accounting to a professional.
Also, in opportunity cost. The commitment required to monitor and maintain the investment portfolio if you do it all yourself. When there may be better uses of your valuable time. That, too, is a cost.
Mutual funds can provide cost-effective diversification. Especially for those with less capital.
Fund companies pool many investors’ funds to spread out investments and risk. Large funds enjoy economies of scale to widely disperse ongoing expenses. Both of these benefit the individual investor.
“Having my money managed by professionals is obviously an advantage, right?”
The same concept holds true for professional asset management within a fund.
By spreading out the portfolio management fees over a wide number of investors, the fund can hire competent asset managers to improve fund performance.
Or so it goes in theory. Having an investment expert make portfolio decisions should be better than non-professionals, such as most people reading this or watching the video.
However, when we drill deeper into mutual funds, professional asset management may not always be the advantage that it seems to be. Yes, a bit of foreshadowing there.
If you prefer reading over audio/video, please refer to “Advantage of Mutual Funds”.
