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Explain the Advantages and Disadvantages of Mutual Funds

There are both advantages and disadvantages to investing in mutual funds. The following is a discussion of some of these advantages and disadvantages.


Advantages of Mutual Funds

One of the main reasons for the creation of mutual funds was to give investors who wanted to make smaller investments access to professional management. However, mutual funds offer many advantages to investors of all types.

Diversification: Investing in a single stock or bond is very risky; owning a mutual fund that holds numerous securities reduces risk significantly. Mutual funds provide diversification, which is crucial to a well-balanced portfolio (diversification is particularly crucial in small accounts).

Professional management: It is difficult and time consuming to pick the best stocks and bonds for your portfolio and to try to beat the benchmarks on these stocks and bonds. Allowing a professional mutual fund manager to make decisions about stocks and bonds for you can save you time and frustration.

Minimal transaction costs: Buying individual stocks and bonds is expensive in terms of transactions costs. Mutual funds offer the advantage of economies of scale in purchases and sales because mutual fund transactions are typically large. “Economies of scale” refers to the fact that mutual fund costs may decrease as the mutual fund’s asset size increases, since brokers may charge lower fees to try to get more of the mutual fund’s business.


Liquidity: Money invested in mutual funds is generally liquid. You can usually sell your shares and collect money from open-ended funds (funds that can create and redeem shares on demand), usually within two business days. If the open-end funds are no-load funds, investors are not required to pay transactions costs when you buy or redeem shares.  Closed-end funds are funds that trade on stock exchanges or over the counter that may trade above or below its net asset value or the value of the fund’s investments.


Flexibility: Owning individual stocks and bonds does not allow for much flexibility in terms of liquidity, or the ability to access your money. You cannot write checks on individual stocks and bonds. However, many mutual funds allow for more flexibility by allowing you to write checks on your account.

Low up-front costs: Certain types of mutual funds have financial benefits that make them less expensive than individual stocks and bonds. For example, no-load mutual funds can be sold and redeemed without incurring any sales charges, and open-ended mutual funds can be purchased at the fund’s net asset value (NAV). A fund’s NAV is calculated daily by subtracting the fund’s liabilities from its assets and dividing the resulting amount by the number of outstanding shares. The benefit of open-ended funds is that you do not need to pay a premium or a sales charge to purchase or sell the shares.

Service: Mutual fund companies generally have good customer service representatives who can answer your questions and help you open accounts, purchase funds, and transfer funds. Mutual fund companies may also offer other services, including automatic investment and withdrawal plans; automatic reinvestment of interest, dividends, and capital gains; wiring funds to and from your accounts; account access via phone; optional retirement plans; check-writing privileges; bookkeeping services; and help with taxes.


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