Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic diversification they offer, as well as the advantages of professional management, liquidity, and customizability.
Key Takeaways
- Mutual funds are popular in part because they offer investors the opportunity to diversify, and therefore spread out their risk over a number of investments.
- Mutual funds appeal to people because they give average investors the opportunity to invest inprofessionally managed funds.
- Shares in mutual funds can be bought and sold relatively easily, due to the high demand and high liquidity for these funds.
- There are numerous mutual funds available that can cover a wide range of interests and investment needs, regardless of the investor.
Diversification
Diversification is the name of the game in investing, as it allows the investor to spread out his total risk over a wide range of investments. To achieve optimal diversification in a self-managed portfolio, the investor or his financial advisor needs to research and track numerous investments in different sectors and markets.
To balance out highly volatile stock holdings, for example, you need to also include highly stable bonds in your portfolio. While highly volatile stocks may end up generating huge gains, they are just as likely to cost you a significant amount of your investment capital. Government or highly rated corporate bonds, conversely, are unlikely to lose any principal value over time and are guaranteed to pay a fixed amount of interest each year. These bonds, therefore, are extremely low-risk but also offer lower profit potential.
This is an extremely simple example of diversification. In reality, complete diversification is much more complex. Mutual funds are popular because all the legwork of creating an optimally diversified portfolio is taken care of by the fund's managers. This intrinsic diversification makes mutual funds generally safer than investing in individual stocks.
Professional Management
Another reason mutual funds are so popular is that they are managed by professionals who have the experience necessary to properly judge the profitability of different investments. Unlike individual investors, fund managers are less likely to succumb to the pitfalls of emotional investing motivated by greed and fear. Fund managers are also uniquely motivated to ensure their funds are as profitable as possible regardless of their own opinions of the companies or governments that issue assets in the fund's portfolio.
In addition, investing in a mutual fund ensures the investor does not need to worry about researching and timing trades. With professional management, the fund's manager handpicks each asset and decides when and how to buy or sell to generate the highest returns.
Liquidity
One of the chief benefits of investing in the stock market is investors can buy and sell shares at will. Similarly, shares in open-end mutual funds can also be purchased or sold at the discretion of the shareholder. While mutual fund shares are not traded on a market like stocks or bonds, shareholders can redeem shares with the fund directly or through a registered broker. Most mutual funds, therefore, are just as liquid as traditional stock investments but with the added benefits of diversification and professional management.
Customizability
Another important factor contributing to the popularity of mutual funds is there is an almost infinite number of products available. Regardless of your investment goals or risk tolerance, there is a mutual fund that meets your needs, from high-risk, high-reward stock funds to minimal-risk funds that offer slower, steadier growth, as well as everything in between.
Advisor Insight
Rebecca Dawson
Dawson Capital, Los Angeles, CA
One of the main reasons mutual funds have become popular is due to their low minimum investment amounts. A typical minimum investment is $1,000 to start, then even less for additional investments or redeployments, making them accessible to most investors.
Moreover, index mutual funds have gained popularity recently since the market indices have performed exceedingly well. The fact that they are diversified across multiple asset classes also makes them attractive.
With that said, there are alternatives to mutual funds with different structures that also provide diversification benefits. Unit investment trusts (UITs) invest in a fixed portfolio of securities usually with a 12-24 month term. Therefore, they do not charge annual expenses like mutual funds, only an upfront commission.
FAQs
Mutual funds are popular because all the legwork of creating an optimally diversified portfolio is taken care of by the fund's managers. This intrinsic diversification makes mutual funds generally safer than investing in individual stocks.
Why are mutual funds a popular investment option? ›
Mutual funds are a popular choice among investors because they generally offer the following features: Professional Management. The fund managers do the research for you. They select the securities and monitor the performance.
What helps explain the popularity of mutual funds? ›
This is because mutual funds offer diversification, which helps spread risk as they consist of a variety of stocks or bonds from different firms.
Why are mutual funds popular research paper? ›
Mutual funds are dynamic financial institutions (FIs) which play a crucial role in an economy by mobilizing savings and investing them in the stock-market, thus establishing a direct link between savings and the capital market.
Are mutual funds still popular? ›
So it's not surprising that passively managed index funds have outrun active funds for years. Finally, as of the end of December according to Morningstar, assets in passive investments including mutual funds and exchange-trade funds exceeded those in active investments, $13.29 trillion versus $13.23 trillion.
Why have mutual funds become so popular? ›
Mutual funds have become an incredibly popular option for a wide variety of investors. This is primarily due to the automatic diversification they offer, as well as the advantages of professional management, liquidity, and customizability.
Why is a mutual fund a good investment? ›
Mutual funds are cost-effective due to their low investment and management fees. Mutual funds have high liquidity, which means that investors can easily buy and sell units without any inconvenience.
Why are investors attracted to mutual funds? ›
Each fund has a money manager responsible for the fund, and the manager's objective is to generate income for investors by investing portfolio assets and protecting the portfolio's value. Mutual funds can hold many different securities which makes them very attractive investment options.
Why are mutual funds preferred? ›
One of the primary benefits is diversification, which reduces the risk of loss by spreading investments across a wide range of assets. Mutual funds also provide professional management, allowing you to leverage the expertise of fund managers who make investment decisions based on their research and analysis.
What are three advantages of mutual funds? ›
Why invest in mutual funds?
- Diversification. Mutual funds give you an efficient way to diversify your portfolio, without having to select individual stocks or bonds. ...
- Low cost. ...
- Convenience. ...
- Professional management.
Diversification, or the mixing of investments and assets within a portfolio to reduce risk, is one of the advantages of investing in mutual funds. A diversified portfolio has securities with different capitalizations and industries and bonds with varying maturities and issuers.
Why mutual funds are better than stocks? ›
Mutual funds pose relatively lower risk than direct stock investing due to diversification. Shares have a higher level of risk compared to mutual funds. The debate of the stock market vs mutual funds is never-ending. You should know the pros and cons of both these options before choosing the right one for you.
Why mutual funds is the future? ›
Mutual funds have evolved as a well-known financial vehicle millions use to invest and build a corpus for different life goals. The industry is poised for growth in the coming days thanks to increasing financial literacy and a shift towards market-linked products.
Why do people still invest in mutual funds? ›
Strategy and Risk Tolerance
Unlike ETFs, mutual funds can offer more specific strategies as well as blends of strategies. Mutual funds offer the same type of indexed investing options as ETFs but also an array of actively and passively managed options that can be fine-tuned to cater to an investor's needs.
What is the most popular mutual fund? ›
Most Popular
- #1. BNY Mellon Corporate Bond Fund BYMMX.
- #2. Miller Intermediate Bond Fund MIFIX.
- #3. Calvert Income Fund CFICX.
The United States has a very large mutual fund market. There are literally hundreds of different fund families and thousands of individual funds available, and all of them are vying for your investment dollars.
Is a popular mode of investing in mutual funds? ›
Single holding means that the mutual fund investment is owned by one individual. This mode offers simplicity and full control to the investor, making it suitable for independent investors who want complete autonomy over their investments. Only the investor can access and manage the account.
Why do people usually invest in mutual funds quizlet? ›
Mutual funds allow people to invest in a variety of companies, in stocks, in bonds, and in other financial assets. A mutual fund is also less risky than purchasing the sticks of only one or two companies.
Why are mutual funds a popular way to save for retirement? ›
Mutual funds are commonly used for retirement planning because they offer diversification, professional management and reduced risk when compared with other investments.
