The Pros and Cons of Trading Mutual Funds
Matt Kaldor is a senior content writer with Better Trades (http://www.bettertradesreview.com), the nation’s No. 1 stock market education company.
Original source of the article: http://www.contentcrooner.com (http://www.contentcrooner.com).
Mutual fund investments are among the most common for individuals in the United States. A mutual fund takes money from many different sources and pools it together to invest in stocks and bonds, as well as other financial instruments. This type of fund is often used by people who are saving for retirement or to reach other financial goals and is often a part of a 401(k) account.
Individuals wishing to invest in mutual funds should keep several things in mind before putting their money at risk:
1. There is no FDIC guarantee with mutual funds. It is possible for an investor to lose money by investing in a mutual fund.
2. There are expenses involved. You will be assessed a management fee and you should factor annual expenses into your cost. Depending on the fund, you may also have tax liability.
3. Just because a mutual fund has generated a profit in the past is no guarantee it will continue to do so. Past performance is no indication of future performance; results are never guaranteed with mutual fund participation.
That being said, the mutual fund can be a way to invest wisely in the marker. Although an investor has a lack of control (the manager controls the sales and purchases), a mutual fund provides a good answer for the diversification needed by most individuals. There’s little day-to-day involvement, as the manager pulls the financial levers.
The mutual fund is legally known as an “open-end company” and has characteristics that are particular to that form of investment. Other pooled investments include closed-end funds and unit investment trusts, with exchange traded funds a close cousin.
An introduction to mutual funds will reveal certain peculiarities that are common. For example:
Mutual funds are managed by separate entities known as “investment advisers.” These are registered through an SEC document.
Investors purchase fund shares from the fund itself, not from the investors in a secondary market like the NASDAQ or New York Stock Exchange.
Mutual funds create new shares and sell them to accommodate new investors. Shares of a mutual fund may be sold back to the fund. The price paid for a mutual fund share is the fund’s per-share net asset value, plus any shareholder fees, such as a sales load.
Investors are often drawn to mutual funds because they have professional management and they’re diversified. Because the funds are created to accommodate average investors, they’re generally affordable and liquid. Drawbacks include the fees, taxes on capital gains, lack of control and uncertainty of the fund’s price.
There are three main categories into which mutual funds fall: money market funds, bond funds and stock funds. The money market funds have the lowest amount of risk because they can only be invested in high quality, short-term investments issued by the United States government, state and local governments, or U.S. corporations. Bond funds pursue strategies designed to create a higher yield, but are placed at risk by bad credit, interest rates and prepayment, which can occur when a bond is paid off early. Stock funds can rise and fall in a hurry and carry the greatest risk, as well as the greatest potential reward.
Before investing in any fund, individuals should read the fund’s prospectus and shareholder report. These documents will show a fund’s investment strategies and offer a clue as to the potential risks. Consider the long-term strategies and risk tolerance before becoming involved. Also consider the long-term effect that fees and taxes will have on returns.
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