Are Mutual Funds Still a Good Idea?

by Geri Terzo, Demand Media
    Some mutual funds have lower account minimums than others.

    Some mutual funds have lower account minimums than others.

    Today's mutual fund is a modern version of the pooled investment product that originated in the 18th century in Europe. By the early 1900s, mutual funds found their way to the U.S., where these investment vehicles evolved into their current incarnation. They continue to provide investors with the diversification that popularized them centuries ago. Mutual funds have been the objects of criticism and competition, but the size of the mutual fund industry grew from $7 trillion in 2003 to more than $11 trillion in 2011, according to the Investment Company Institute's 2012 Fact Book.

    Overview

    Mutual funds are investment vehicles run by professional money managers. They combine the money of numerous investors, which allows money managers to make sizable investments not typical of the average investor. A mutual fund's net asset value -- the total value of the fund -- is calculated at the end of each day's trading session. Fees are a chief criticism of mutual funds. Most funds charge investors between 1 and 2 percent of assets managed, but some funds charge only a fraction of that.

    Active Management

    The debate over active fund management, in which fund managers hand-select investments, versus passive fund management, which replicate trading in a market index, has raged for decades. Active fund managers are criticized because they're paid to produce returns that are better than a specific market index but often fail at that task. In the five years from June 2007 to June 2012, less than 33 percent of active funds delivered the returns they promised to investors, according to a 2012 Market Watch article.

    Passive Management

    The concern about passive funds is that investors could miss out on profits by investing in funds that only strive to perform as good as stock market indexes. Passive fund managers align the fund with another market index, make infrequent changes and let the fund perform as the benchmark does. In exchange for the laid-back management style, passive fund managers charge lower fees compared to their active-management counterparts. In the decade beginning in 2002, investors preferred passively managed funds to active funds, according to a 2012 CNBC article.

    Size

    If market size is any indication, mutual funds are still appealing to investors. In 2011, individuals saving for retirement alone had more than $4 trillion allocated to mutual funds, according to the Investment Company Institute. Indeed, retirement funds account for two-fifths of the mutual fund industry's overall assets even after certain mutual funds lost 25 percent of their value in 2008. Individuals saving for retirement feel that stock mutual funds are a better idea than bond funds. Almost 50 percent of assets are invested in stock mutual funds, while less than 20 percent of assets are directed into bond funds.

    Competition

    Mutual funds have brushed up against new competition over the years. Exchange traded funds, or ETFs, resemble mutual funds in that they contain many different financial securities in one fund. Unlike mutual funds, however, ETFs can be traded like stocks in the markets. ETFs overshadowed mutual funds in the 10-year period leading up to 2012. In that time, investors redirected assets from mutual funds to ETFs, increasing the size of the latter 14-fold, according to a 2012 CNBC article.

    About the Author

    Geri Terzo is a business writer with more than 15 years of experience reporting on Wall Street. Her career has included work as a chief guest booker at Fox Business, segment producer at CNBC and journalist at "IDD Magazine," "Infrastructure Investor" and the "Financial Times." Terzo is a graduate of Campbell University, where she earned a B.A. in mass communication.

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