Have you ever noticed all the good things that come in threes, like the primary colors, the rings in a circus or the kittens that lost their mittens? Well, that’s kind of why mutual funds may be an appropriate investment vehicle for many people. Mutual funds offer three practical benefits.
What are Mutual Funds?
At the heart of the mutual fund is a professionally managed investment portfolio. That portfolio is managed for a large pool of investors, each of whom owns a portion of it. Coincidentally, this structure is called a “pooled investment.”
Three Main Advantages
Owning mutual funds gives investors immediate diversification, unbiased investment management and quick liquidity.
1) Immediate Portfolio Diversification
Diversification is a technique to reduce the risk of owning a single investment. It’s really as simple as investing in more than just one stock or bond. By allocating a portion of investment dollars to a number of different securities you effectively spread the risk that any one of them is going to blow up your portfolio.
Mutual funds deliver immediate diversification because your investment buys the whole mutual fund portfolio, not just a portion of it. Whether you invest $1,000 or $100 you own the exact same number of securities. You just own more or less of them.
Most mutual funds own dozens of securities. So, you get a diversified portfolio in one fell swoop, rather than building it piecemeal over time, which in itself could be pretty risky. And then there’s the economy of this instant diversification.
To replicate a mutual fund’s portfolio by buying even a token amount of each of the securities in it might be cost prohibitive…unless you’re talking about investing hundreds of thousands of dollars…or more.
2) Unbiased Investment Management
Okay, for the average individual investor, this may actually be the most valuable benefit of a mutual fund. The people managing your money generally approach that responsibility objectively, without bias or emotion. They neither love nor hate any of the securities in the portfolio. They own them only for what they might contribute to its success.
Mutual funds are managed by skilled, very-experienced investment professionals. Owning a mutual fund effectively puts you in the same league as a large institution or hyper-wealthy tycoon. You have someone managing your money who has been through up markets and down markets and knows how to navigate each. They take the emotion out of investing…if you let them.
3) Really Quick Liquidity
Liquidity is an appropriate term to describe how easily money flows into and out of a mutual fund. You can buy or sell shares without impacting the price of the fund and can expect that you’ll settle the transaction very quickly.
Typically, you’ll know by the end of the day the price at which you bought or sold a mutual fund. And generally, the transaction will settle the next day (maybe two or three days at the longest). That’s when money will be due to the fund or to you.
Now Some Mechanics
Investors buy shares of mutual funds directly from the company that manages the underlying portfolio. As new money comes in, the portfolio manager buys more securities. When investors sell, the manager redeems their shares by selling some of the portfolio. This structure has an unintended consequence.
Sometimes capital gains are generated by these redemptions. And those gains get passed on to the mutual fund’s investors…even those that haven’t sold a share. But that doesn’t keep mutual funds from remaining very appropriate investment vehicles for many people.