One dilemma faced by virtually all investors is the question of whether to buy individual investments, such as stocks and bonds, or to buy mutual funds or ETFs. While mutual funds don’t meet the needs of every investor, there are three major reasons why investing in mutual funds could be a better choice for many investors.
Why Invest In Mutual Funds?
1. Increased diversification and reduced risk
Mutual funds allow investors to build a diverse investment portfolio and reduce the risk while owning just a few different types of mutual funds.
Whereas you pay commissions and other transaction costs every time you buy or sell individual stocks and bonds, you can buy many mutual funds without incurring any transaction costs at all.
To build a portfolio of individual stocks and bonds as diverse as you can create through mutual funds, you’d need to spend hours researching and monitoring your holdings on a weekly basis.
Mutual Funds vs. ETFs
Once you’ve decided to buy mutual funds rather than individual stocks or bonds, there’s another key question you need to ask before you buy a mutual fund: should you buy a comparable ETF instead? I personally prefer to invest in ETFs but each investor is different, with different needs and different goals. For help deciding between mutual funds and ETFs, read Understanding Exchange Traded Funds.
The two most important factors to consider before you buy a mutual fund are fees and returns. Only one statistic among the dozens of figures that mutual fund companies publish annually will tell you what you need to know about a fund’s fees and performance: total return after taxes and expenses. This statistic shows the return that fund-holders have made on their investment after all taxes and expenses are taken into account. When researching a fund’s total return after taxes and expenses, be sure to:
Avoid “hot” mutual funds
Consider the mutual fund’s total return after taxes and expenses over the past 5–10 years, not just the past year or so. And remember that past performance is no guarantee of future results.
Look for low expense ratios
Never buy an index fund with an expense ratio above 0.50% or an actively managed fund with an expense ratio above 1.50%.
Load Funds vs. No-Load Funds
Loads are fees that mutual funds charge investors in addition to standard mutual fund fees, such as expense ratios. Load funds charge these fees, whereas no-load funds don’t. Though you might think that load funds could get away with charging additional fees only if they outperformed no-load funds, studies have shown that most load funds both underperform no-load funds and cost more in fees along the way. With thousands of inexpensive no-load funds available, there’s just no good reason to buy load funds.
Where You Can Buy Mutual Funds
You can buy mutual funds directly from the mutual fund company or better yet, set up an investment account at one of the brokerage houses listed below. By setting up an account at an online brokerage, you aren’t limited to the types of investments you can purchase.
- Scottrade – you can thousands of different mutual funds.
- optionsXpress – one of the easiest online brokerages to set up. No paper forms or signatures required.
- TradeKing – offers regular trades and broker assisted trades for only $4.95.
- tradeMonster – offers mobile trading.
- optionshouse – this is basically the least expensive online brokerage for investors.
- Zecco – has commission free trades available.