Investments in equity and debt have distinctive features. Stocks earn money quickly, but are dangerously volatile. Bonds are very safe places to keep your money, but sometimes the return on your investment isn’t quick enough. Although both of these investments have different advantages, there doesn’t seem to be a middle ground. The best of both investments can be achieved through a mutual fund. When you invest in a mutual fund, you are pooling your money with other investors to buy a selection of stocks and bonds. The stocks and securities in the mutual fund are normally chosen by the manager of the mutual fund. Much like with stocks, when you invest in a mutual fund you are essentially buying shares of the fund. Thus, the way you make money is very similar to that of equity investments.
Advantages to mutual funds
Mutual funds are a desirable alternative to choosing stocks and bonds alone because someone invests your money for you. Mutual funds offer moderate risk and moderate rewards on your investment. Keep in mind that there is still a risk on your investment since you own a share of the mutual fund, yet this risk is less than if you invested in stocks alone. The risk is less than with stocks because trading many stocks and bonds in the same fund dilutes the losses from your investments. Any losses on investments in mutual funds are diluted by the fact that a loss on a stock is distributed over every share in the mutual fund. Also, even if one stock in the mutual fund loses money, other earning stocks can mitigate the effects of the losing stock. The same principle applies to the devaluation of any securities held by the mutual fund.
Another reason that people like mutual funds is because they are liquid investments. Shares of a mutual fund can be traded like shares of a company. Investment choices made by the mutual fund are left at the discretion of the manager; however you still get to make decisions about your individual shares in the mutual fund.
Money is made on your investment in multiple ways when you invest in a mutual fund since multiple forms of investment are made. Distributions accumulate on investments also. These come from any money earned as dividends or interest on securities or stocks in the mutual fund. Money can be earned on your investment as capital gains when you sell your shares in the mutual fund. This is not always advisable because selling your shares in a mutual fund is essentially cashing out of any future distributions the will be made unless you buy back your shares at another time.
Disadvantages to mutual funds
While mutual funds are good ways to invest your money, there are downsides. Firstly, mutual funds are not without risk. While any stock losses are diluted, this does not mean that risk is entirely eliminated from your investment. In addition, mutual funds do not normally allow you to choose specific stocks or bonds. Normally the manager does this. While you do get to know what stocks and bonds are in the mutual fund, you do not get to make executive decisions about how the fund deals with these investments. This often means that savvy investors need to take the back seat and allow the manager of the mutual fund to make investments they would make differently. Finally, mutually funds are taxed and fees are associated with investing. These two properties of mutual funds reduce the value of your earnings.