Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic diversification they offer, as well as the advantages of professional management, liquidity, and customizability.
Key Takeaways
- Mutual funds are popular in part because they offer investors the opportunity to diversify, and therefore spread out their risk over a number of investments.
- Mutual funds appeal to people because they give average investors the opportunity to invest inprofessionally managed funds.
- Shares in mutual funds can be bought and sold relatively easily, due to the high demand and high liquidity for these funds.
- There are numerous mutual funds available that can cover a wide range of interests and investment needs, regardless of the investor.
Diversification
Diversification is the name of the game in investing, as it allows the investor to spread out his total risk over a wide range of investments. To achieve optimal diversification in a self-managed portfolio, the investor or his financial advisor needs to research and track numerous investments in different sectors and markets.
To balance out highly volatile stock holdings, for example, you need to also include highly stable bonds in your portfolio. While highly volatile stocks may end up generating huge gains, they are just as likely to cost you a significant amount of your investment capital. Government or highly rated corporate bonds, conversely, are unlikely to lose any principal value over time and are guaranteed to pay a fixed amount of interest each year. These bonds, therefore, are extremely low-risk but also offer lower profit potential.
This is an extremely simple example of diversification. In reality, complete diversification is much more complex. Mutual funds are popular because all the legwork of creating an optimally diversified portfolio is taken care of by the fund's managers. This intrinsic diversification makes mutual funds generally safer than investing in individual stocks.
Professional Management
Another reason mutual funds are so popular is that they are managed by professionals who have the experience necessary to properly judge the profitability of different investments. Unlike individual investors, fund managers are less likely to succumb to the pitfalls of emotional investing motivated by greed and fear. Fund managers are also uniquely motivated to ensure their funds are as profitable as possible regardless of their own opinions of the companies or governments that issue assets in the fund's portfolio.
In addition, investing in a mutual fund ensures the investor does not need to worry about researching and timing trades. With professional management, the fund's manager handpicks each asset and decides when and how to buy or sell to generate the highest returns.
Liquidity
One of the chief benefits of investing in the stock market is investors can buy and sell shares at will. Similarly, shares in open-end mutual funds can also be purchased or sold at the discretion of the shareholder. While mutual fund shares are not traded on a market like stocks or bonds, shareholders can redeem shares with the fund directly or through a registered broker. Most mutual funds, therefore, are just as liquid as traditional stock investments but with the added benefits of diversification and professional management.
Customizability
Another important factor contributing to the popularity of mutual funds is there is an almost infinite number of products available. Regardless of your investment goals or risk tolerance, there is a mutual fund that meets your needs, from high-risk, high-reward stock funds to minimal-risk funds that offer slower, steadier growth, as well as everything in between.
Advisor Insight
Rebecca Dawson
Dawson Capital, Los Angeles, CA
One of the main reasons mutual funds have become popular is due to their low minimum investment amounts. A typical minimum investment is $1,000 to start, then even less for additional investments or redeployments, making them accessible to most investors.
Moreover, index mutual funds have gained popularity recently since the market indices have performed exceedingly well. The fact that they are diversified across multiple asset classes also makes them attractive.
With that said, there are alternatives to mutual funds with different structures that also provide diversification benefits. Unit investment trusts (UITs) invest in a fixed portfolio of securities usually with a 12-24 month term. Therefore, they do not charge annual expenses like mutual funds, only an upfront commission.
FAQs
Mutual funds perform well due to professional management, diversification, and access to various securities, benefiting small investors. Careful selection is crucial to avoid losses in the fluctuating market.
Why have mutual funds become so popular? ›
Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic diversification they offer, as well as the advantages of professional management, liquidity, and customizability.
What helps explain the popularity of mutual funds? ›
This is because mutual funds offer diversification, which helps spread risk as they consist of a variety of stocks or bonds from different firms. However, (III) it is not necessarily true that mutual funds frequently outperform market indices.
What is the main reason people choose to invest in mutual funds? ›
The primary reasons why an individual may choose to buy mutual funds instead of individual stocks are diversification, convenience, and lower costs.
Why are mutual funds a popular way to save for retirement? ›
Mutual funds are commonly used for retirement planning because they offer diversification, professional management and reduced risk when compared with other investments.
When did mutual funds become popular? ›
Mutual funds didn't really capture the attention of American investors until the 1980s and 1990s, when investors in them hit record highs and realized incredible returns. They are now mainstream investments and form the core of individual retirement accounts.
Why are mutual funds growing? ›
According to Ashwini Kumar, Head Market Data of ICRA Analytics, mutual fund penetration has been steadily improving in smaller towns and cities backed by increasing awareness among people, the growing interest among retail investors for investing in equities through the MF route and the opening up of branches of AMCs ( ...
Are mutual funds still popular? ›
Mutual funds were the most common type of investment company owned, with 68.7 million US households, or 52.3 percent, owning mutual funds in 2023.
What is a benefit to mutual funds quizlet? ›
Mutual funds offer many benefits. Some of those benefits include: the ability to invest with small amounts of money, diversification, professional management, low transaction costs, tax benefits, and the ability to reduce administrative functions.
Why do people usually invest in mutual funds quizlet? ›
Mutual funds allow people to invest in a variety of companies, in stocks, in bonds, and in other financial assets. A mutual fund is also less risky than purchasing the sticks of only one or two companies.
A mutual fund is a pool of money managed by a professional Fund Manager. It is a trust that collects money from a number of investors who share a common investment objective and invests the same in equities, bonds, money market instruments and/or other securities.
What are the pros and cons of mutual funds? ›
Some of the advantages of mutual funds include advanced portfolio management, dividend reinvestment, risk reduction, convenience, and fair pricing, while disadvantages include high expense ratios and sales charges, management abuses, tax inefficiency, and poor trade execution.
How does a mutual fund make money? ›
Mutual funds make money by charging investors a percentage of assets under management and may also charge a sales commission (load) upon fund purchase or redemption. Fund fees, called the expense ratio, can range from close to 0% to more than 2% depending on the fund's operating costs and investment style.
What is the benefit of investing in mutual funds? ›
Mutual funds offer several benefits to investors, including professional management, diversification, liquidity, low cost, tax benefits, affordability, safety, and transparency. However, investors need to consider several factors before investing in mutual funds.
Why are mutual funds better than other investments? ›
Low Cost — An important advantage of mutual funds is their low cost. Due to huge economies of scale, mutual funds schemes have a low expense ratio. Expense ratio represents the annual fund operating expenses of a scheme, expressed as a percentage of the fund's daily net assets.
Why are mutual funds a safe investment? ›
Mutual fund investments when used right can lead to good returns, keeping risk at a minimum, especially when compared with individual stocks or bonds. These are especially great for people who are not experts in stock market dynamics as these are run by experienced fund managers.
Why mutual funds are selling? ›
Mutual fund managers have some flexibility over capital gains and can often offset them by selling investments that have lost value and realizing a capital loss.
Are mutual funds popular in USA? ›
The United States has a very large mutual fund market. There are literally hundreds of different fund families and thousands of individual funds available, and all of them are vying for your investment dollars.
