Mutual Funds
Mutual funds have always been a popular investment for investors. Due to their simplicities and other attributes they provide great benefits to investors who may have limited knowledge or money. The following reasons may help you decide if mutual funds are best for you and your situation.
Diversification
A common rule for both large and small investors is asset diversification. In order to manage risk, diversification involves the mixing of investments within a portfolio. An example of this would be if you bought stock in the retail sector and then offset that with stocks in the industrial sector. You would be reducing the impact of the performance of any one security in your entire portfolio. To achieve a truly diversified portfolio, it may be necessary to buy stocks with different capitalizations from different industries, as well as bonds that have varying maturities from different issuers. As an individual investor this can be quite costly.
When you purchase mutual funds, you are given the immediate benefit of instant diversification and asset allocation without having a large amount of cash in order to create individual portfolios. A caveat, however, is that purchasing one mutual fund might not give you adequate diversification. Be sure to see if the fund is sector or industry specific. As an example, investing in an oil and energy mutual fund might spread your money over fifty companies, but if energy prices fall, your portfolio is likely to suffer as well.
Economies of Scale
The easiest way to understand economies of scale is to think about volume discounts. In many discount stores, for instance, the more of one product that you purchase, the cheaper that product becomes. If you were to buy a dozen donuts, the price per donut is usually cheaper than if you were to buy a single one. This scenario occurs in the purchase and sale of securities. If you were to only buy one security at a time, the transaction fees will be relatively large.
Mutual funds take advantage of their buying and selling size and thereby reduce transaction costs for investors. Buying a mutual fund gives you the ability to diversify without the numerous commission charges. You would have to pay more transaction fees every time you wanted to modify your portfolio, and you can see the costs begin to add up. Mutual funds are able to make transactions on a much larger scale at a cheaper price.
Investors don't have the exact sums of money to buy round lots of securities. One to two hundred dollars is usually not enough to buy a round lot of a stock, especially after deducting commissions. Investors can purchase mutual funds in smaller denominations, which can range from $100 to $1000 minimums. Rather than having to wait until you have enough money to buy higher-cost investments, you can begin right away in purchasing mutual funds.