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Because mutual funds are a financial instrument of great popularity and used by small savers, we will know what their advantages and disadvantages are. Financial markets have been prudent to generate, over the years, instruments that can be used by people with a reduced ability to save. In this way, people who never imagined participating in the markets, with mutual funds can do so, as with the ETFs that we have already analyzed. We will know the strengths and weaknesses of a mutual fund.
How do those who invest in mutual funds get benefits?
What we must first make clear, and one of the most important things for investors is how they get the benefits. Those who decide to be part of a mutual fund are obtaining shares or a “share share” of that fund. At the time of receiving the benefits, the investor will receive according to the percentage of shares quotas he owns.
A mutual fund can make profits from dividends distributed by the set of shares that are part of its portfolio. You can also do it for the interests generated by the fixed income assets that make up your portfolio. When the fund distributes these benefits, it offers the investor two alternatives: a check for the amount obtained in accordance with their participation, or an extension of their quota shares.
Another way through which investors obtain benefits is as follows: the assets that are part of the mutual fund investment portfolio increase their market price. If the fund does not sell them, its capital will have increased, therefore, it will increase the value of the share share or share held by each investor.
Finally, if mutual funds sell new participations and these have increased their price, administrators usually transfer these benefits to the investors of each of those funds.
Advantages of investing in mutual funds
Mutual funds offer numerous advantages to investors. Hence its main attraction, especially for those who lack a thorough knowledge of the movements of financial markets.
When we analyzed the quoted funds in Club de Capitals, we saw that they could replicate, for example, a stock index such as the S&P 500 and the benefits were obtained from the behavior of that index.
In the case of mutual funds, they seek the best opportunities offered by different financial assets. To do this, they have a professional administration that is permanently engaged in seeking these opportunities. It is what we call an active administration.
This allows investors who do not have the necessary time or knowledge to participate in the financial markets. A professional administration has full-time specialists dedicated to finding the best benefits for investors.
Mutual funds integrate their investment portfolio with different types of financial assets. In addition, as we have indicated, they buy and sell looking for the best opportunities. When an investor buys a stake in a mutual fund, its risk is distributed among all the assets that make up the fund’s portfolio. This is a way to minimize the risk to investors.
And, of course, the more diversified the fund’s portfolio, the greater the risk diversification.
Economics of scale, to act like a big being small
When a mutual fund is established, it does so with large amounts of money. This comes from small, medium and large investors. In this way, mutual funds can buy significant amounts of different assets, reducing transaction costs.
In this same sense, a mutual fund can acquire shares of an Initial Public Offering, something that small investors are forbidden. In general, IPOs tend to be great opportunities as the price of the stock rises in the first rounds.
Participating in a mutual fund is simple
If an investor is interested in buying a stake in a mutual fund, the procedure is quite simple. Many banks and broker companies have their own line of mutual funds among their products.
In addition, entering these instruments is not expensive as it can be done with small amounts of money. Many funds accept investments from $ 100. In the same way, withdrawing from a mutual fund is simple and can be done at the time the investor wishes.
Mutual funds are regulated by the regulatory bodies of each country. This offers a level of security for those who wish to participate in it.
Disadvantages of mutual funds
We have analyzed the advantages of mutual funds. And as you can see they are important. However, some of the qualities that make it an attractive instrument can act as a limitation or disadvantage. Let’s see what they are.
The risks of an active administration
Among the advantages, we have pointed out the active administration. Having full-time professionals looking for opportunities is important. But, here is a disadvantage. Professionals are not infallible and some decisions can lead to market losses. However, mutual fund administrators will also receive their pay. This active management leads to higher fees for investors.
Higher costs and fees
In relation to the previous point, mutual funds incur higher costs. Tracking market movements in detail requires a team of people who increase the salary costs incurred by the fund. Periodic balances and distribution of summaries to investors cost money.
As the fund carries out multiple operations, it incurs expenses that are then transferred to investors. It is important, before buying a stake in a mutual fund, to know the costs that will have to be faced, since these will be deducted from the benefits, and in case of losses with a decrease in the value of the share quota.
Diversified risk can conspire against results
We have already pointed out as an advantage the diversification of risk. Occasionally, wide diversification can act as a disadvantage. This is because the returns obtained from some assets can be offset negatively by losses in others.
The cash drag problem
Mutual funds must have a substantial portion of their cash portfolio. This allows them to face the reimbursements they must make daily. And as we all know, money that remains immobilized and in cash does not generate profitability. This is called cash carryover.
Beyond the disadvantages we have described in this article, mutual funds are very popular instruments. You can become an expert in this and other financial instruments.