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.
When did mutual funds become popular? ›
Mutual funds didn't really capture the attention of American investors until the 1980s and 1990s, when investors in them hit record highs and realized incredible returns. They are now mainstream investments and form the core of individual retirement accounts.
Why are mutual funds popular for investors on Quizlet? ›
Mutual funds are popular because they can help individuals diversify while using professional expertise to make investment decisions.
What is so special about mutual funds? ›
Mutual funds let you pool your money with other investors to "mutually" buy stocks, bonds, and other investments. They're run by professional money managers who decide which securities to buy (stocks, bonds, etc.) and when to sell them. You get exposure to all the investments in the fund and any income they generate.
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.
Why have mutual funds become so popular? ›
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 in professionally managed funds.
Are mutual funds still popular? ›
Mutual funds are one of the most popular ways to invest in the stock and bond markets, especially as part of employer-sponsored 401(k) plans and self-directed IRAs.
Why are investors attracted to mutual funds? ›
Advantages of Mutual Funds. There are several specific reasons investors turn to mutual funds instead of managing their own portfolio directly. The primary reasons why an individual may choose to buy mutual funds instead of individual stocks are diversification, convenience, and lower costs.
Why are mutual funds a popular way for investors to achieve diversification? ›
Mutual funds give you an efficient way to diversify your portfolio, without having to select individual stocks or bonds. They cover most major asset classes and sectors.
Why are mutual funds attractive to individual investors? ›
Affordability. Most mutual funds set a relatively low dollar amount for initial investment and subsequent purchases. Liquidity. Mutual fund investors can easily redeem their shares at any time, for the current net asset value (NAV) plus any redemption fees.
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.
Why are mutual funds better than stocks? ›
Mutual funds or stocks—which one offers more security? Mutual funds typically offer more security compared to individual stocks because they spread investments across various assets, reducing the impact of market fluctuations. However, the level of security depends on the specific mutual fund or stock chosen.
What is mutual funds and its advantages and disadvantages? ›
To conclude, Mutual Funds offer numerous benefits, including professional management, diversification, liquidity, and tax efficiency. However, it's crucial to consider factors like costs, exit loads, over-diversification, and volatility before investing in them.
Why are mutual funds appealing? ›
Many people see mutual funds as a great investment vehicle. Consider the advantage: Because they're funds that contain a variety of assets, you get automatic diversification. If Company A's stock crashes, you'd lose a lot if you were directly invested in it.
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.
What is a major advantage of mutual funds quizlet? ›
What is the main advantage of a mutual fund? They give small investors access to professionally managed, diversified portfolios of stocks, bonds, and other securities.
When did mutual funds become covered? ›
Company stocks acquired starting in 2011, as well as shares of stock in dividend reinvestment plans and mutual-fund shares purchased in 2012 and afterward, are designated as covered securities.
What were the best investments in the 1970s? ›
Gold Was The Number One Asset Of The 1970s
The best asset to own in the 1970s was gold, which went from $35 an ounce at the beginning of the decade to as high as $850 by 1980. Investors sought a hard asset that could go toe-to-toe with inflation and hold its value over time, and the yellow metal fit the bill.
Are mutual funds popular in the USA? ›
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.
What was the first mutual fund in 1924? ›
In 1924, 100 years back - the first mutual fund in the world was born. Edward Leffler created the first mutual fund in the world - Massachusetts Investment Trust in US. It democratised the investments and allowed small investors to participate in the US capital markets.
