In Part I, we went through mutual fund basics; what they are, the different types, and what to keep in mind when certain mutual funds are being recommended to you by your friendly neighbourhood financial adviser or investment professional.
So why buy mutual funds in the first place?
- Diversification is the main advantage. If you do not have the time (or desire) to research individual stocks and bonds, owning a mutual fund gives you exposure to a large number of them. Therefore, the inherent risk in owning shares in a company is spread out. In other words, if a company goes out of business, the impact on your mutual fund portfolio would be less than if your portfolio consisted of just shares in that company. Mutual funds also give you the opportunity to own a lot more than you would normally be able to do the amount of cash you have invested. i.e. All I want for Christmas is ONE share of Berkshire Hathaway – all yours for the low, current price of $117, 925.
- Transaction Cost Savings – because mutual funds trade in larger volumes, their transaction costs would be cheaper than what it would be if you bought the stocks yourself.
- Liquidity – for the most part, mutual fund shares should be pretty easy to sell which will then be converted to cash.
- Simplicity – just hop on over to your nearest bank, investment or insurance company and they will be MORE THAN happy to sell you some of their products. You can make lump sum purchases or set up automatic purchases every month.
- Professional Management – TECHNICALLY this is an advantage. It is probably the main advantage that your financial planner/adviser will tell you. Come on, you have a PROFESSIONAL investment manager handling your portfolio for you! Unfortunately, there has been no statistical data proving that actively managed funds perform better than the stock market on a long term basis. Every year, there are managers who do achieve returns higher than the market, but very seldom can they consistently do it year after year. So I will, very grudgingly, add it as an advantage. Cause it is… sorta. Not really. But I digress.
So what are the disadvantages?
- Professional Management – So I kind of cheated. Like I mentioned before, there is no statistical proof that actively managed mutual funds perform better than the market itself. If it was, then everyone who has mutual funds should be RICH! Ya, right. You know who is though? The mutual fund managers and companies. Why is that? When we MAKE money on our mutual funds, they MAKE money. When we LOSE money, they still MAKE money. Something wrong with this picture?
- Costs – mutual funds aren’t cheap! They are, after all, a product. Not only do you have to pay for the professional fund management, you also have to pay for all the shiny advertising material that you receive when you first purchase the mutual fund. You also pay for someone to keep track of how many shares you own. Oh, and that friendly neighbourhood financial planner of yours? Yup, you are also paying them for selling you the mutual fund in the first place.
- Taxes – if you are purchasing mutual funds in your RRSPs, then this isn’t an issue. If you are holding mutual funds in a non-registered account, you have to be aware of the tax implications! When the fund manager sells a security, it may trigger a capital gain. These gains are then passed on to the investors, who bear the responsibility of paying for the taxes associated with it.
Like I said, there is a lot to learn about mutual funds. So a question that may follow all this juicy information would be: so, what mutual funds do you own? Er, well, like I mentioned before, I don’t personally own mutual funds. BUT, that doesn’t mean I wouldn’t recommend them. Stay tuned for Part III in the series where I will delve into the world of index mutual funds! I will show you how you can make the most of the advantages that are provided by mutual funds, while limiting the inherent disadvantages as well. All for the low price of… kidding!
What do you think? More info than you ever wanted to know about mutual funds?