If you're looking for a way to diversify your investment portfolio, one option is to buy a mutual fund. A mutual fund is a collection of securities such as stocks or bonds that are similar in nature. A fund is managed by an investment professional, known as a fund manager. While funds offer benefits such as diversification and liquidity, they can also have some disadvantages.
Mutual funds typically include a variety of expenses that can diminish your returns. Unless you buy a no-load fund, you will have to pay any associated sales charges and commissions, as well as other expenses such as annual fees and routine operating costs. Unlike with taxed-deferred investments such as annuities or traditional IRAs, mutual fund earnings from a taxable account are not tax-deferred, so you will pay to pay capital gains taxes on your earnings in the current tax year.
No Investment Control
While a mutual fund allows you to select a general type of investment by industry or sector, the fund manager is responsible for choosing the specific investments, and you have no input on this. The fund manager also can buy and sell individual securities as he sees fit. Thus, you are placing your complete trust, as well as your money, in the fund manager's hands.
If you consider yourself a conservative investor, mutual funds may not be for you. As when investing in individual stocks, mutual funds do not come with any guarantees. While there is a chance your fund will outperform low-return investments such as certificates of deposit or fixed annuities from insurance companies over the long haul, you can also lose your proverbial shirt if the market collapses.
While mutual funds' diversity offers balance and stability, it can also minimize your investment return. You have much less chance of making a killing than if you invested in individual stocks that suddenly take off. In effect, you are trading the possibility of greater returns for a reduction in risk. Diversification also won't be of much help if the market steadily declines and investment values drop across the board.
Chris Joseph writes for websites and online publications, covering business and technology. He holds a Bachelor of Science in marketing from York College of Pennsylvania.