Top 5 Benefits of Mutual Funds in 2023

Nov 06, 2022
4 People Read
Table of Contents
  1. What is a mutual fund?
  2. Types of mutual funds
    1. Money market funds
    2. Stock funds
    3. Target-date funds
    4. Bond funds
  3. Benefits of mutual funds
  4. Drawbacks of mutual funds
  5. Mutual fund managers
  6. How to earn with mutual funds
  7. Should you invest in mutual funds?
  8. Other considerations before investing in mutual funds
  9. Final thoughts

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Mutual funds are one of the most popular investment vehicles used by investors today. They provide many benefits that center around diversification and receiving steady returns when the market is good. However, there are some downsides you should consider before investing in mutual funds.

Continue reading to find out the top benefits of mutual funds and whether or not this tried and true investment vehicle is right for you.

What is a mutual fund?

Mutual funds are actively managed funds that pool money from many investors and invest in traditional assets like stocks, bonds, and other investments. Mutual funds are managed by professional money managers who have a deep understanding of the financial services industry and how to generate positive returns for their investors.

One of the best parts about mutual funds is that anyone can get involved in investing in them. Unlike hedge funds, mutual funds don’t require you to be an accredited investor (which means making $200,000 per year or having a net worth of over $1 million) and there aren’t typically income requirements to start investing with mutual funds.

Mutual funds are available for retail investors using Robinhood and other popular trading apps. They also tend to generate high returns for robo-advising apps like Betterment and Wealthfront.

Types of mutual funds

While there are plenty of different types of mutual funds available, the four most common types of mutual funds are:

  • Money market funds

  • Stock funds

  • Target-date funds

  • Bond funds

Money market funds

Money market funds are the safest type of mutual funds and generate predictable returns for investors. However, money market funds invest in short-term investments like Treasury Bills and therefore don’t generate high returns. 

These mutual funds are meant for those that want a return on their money in line with the amount they’ll receive from a checking account or certificate of deposit (CD).

Stock funds

Stock funds (or equity funds) primarily invest in stocks across major exchanges around the world. These stocks may consist of domestic stocks, international stocks, and foreign exchange stocks (Forex). 

Since stocks are more volatile than money market accounts, they stand to generate higher returns for investments than most other mutual funds. Additionally, investing in an equity fund is one of the best ways to create a diversified portfolio since you’ll be exposed to plenty of different stocks across exchanges around the world. 

Some types of equity funds include:

  • Domestic stocks

  • ESG companies

  • Market cap

  • International stocks

Target-date funds

As the name may suggest, target-date funds have a date when the investment is to become available for the investor. This type of mutual fund is meant for a single investor, and the most common target-date funds are for investors nearing retirement.

As the target-date approaches, the investments in the target-date fund start to become more conservative and move away from high-risk stocks. Most investors near retirement choose to diversify and protect their nest egg with a portfolio consisting of bonds and other safer investments.

Bond funds

Bond funds are meant for investors who want consistent returns without as much market risk as stock funds. These funds are also known as fixed-income mutual funds and are starting to become more popular for investors close to retirement.

Bond funds are actively managed by mutual fund managers and tend to target bonds that are undervalued and attractive to investors. 

Benefits of mutual funds

Now that you know what mutual funds are and the different types of mutual funds, let’s get into the benefits you’ll get from investing in mutual funds and why they are such an attractive investment for many people today.

  • Diversification. Mutual funds are the ultimate diversification vehicle. They invest in many assets across different sectors and give investors exposure to different stocks, bonds, and money market accounts. This minimizes your risk and ensures that, if one or more stocks in the fund fall drastically, you’ll be diversified and won’t have to worry about your entire investment portfolio falling with it.

  • Consistent returns. While mutual funds may not generate outsized returns like hedge funds, you’ll find that mutual funds provide consistent returns for investors who have a long-term mindset.

  • Funds are managed by professionals. Mutual fund managers are some of the smartest people in the world. They have a comprehensive understanding of the financial market and know how to generate returns for investors. 

  • Some have low costs. Mutual funds are great for new investors since some have low fees associated with joining the fund. For example, Charles Schwab offers mutual funds without minimum investment requirements and no transaction fees.

  • High liquidity. Since most mutual funds are listed on stock exchanges, these investments can be easily converted into cash on short notice. Unlike real estate investing, hedge funds, and REITs, mutual funds are great for those that are looking for consistent returns and high liquidity.

Drawbacks of mutual funds

While mutual funds are great and provide many benefits for investors, there’s no denying that there are some downsides. Below are the most common drawbacks of mutual funds you should consider before investing.

  • Some mutual funds have high fees. Some mutual funds charge high fees to gain access to their expert management and high returns. However, down years can cause some or all of your gains to be wiped out along with the fees you must still pay to the mutual funds management team when your investments lose value.

  • FDIC does not cover mutual funds. Like all investments, mutual funds may decrease in value and losses are not covered by the FDIC.

  • Cash is required for mutual funds. Mutual funds have what’s known as a cash drag since cash is required to invest in mutual funds while generating no returns for investors.

Mutual fund managers

Mutual fund managers are responsible for managing the investment decisions of the fund in hopes to maximize the returns for investors. Like hedge fund managers, most mutual fund managers have extensive experience in the financial services industry with advanced degrees from top MBA programs around the world. 

Those who want to become a mutual fund manager should have a bachelor’s degree from a reputable business school and should consider going to graduate school for a Master’s in Business Administration (MBA) from a business school in the area. We’d recommend trying to get an internship with a mutual fund company or investment bank to get your foot in the door while you’re in college and lead to opportunities once you’re done school.

How to earn with mutual funds

Mutual funds give investors several way to earn returns. Below are the three ways you get a return for your money when investing in mutual funds:

  • Dividends. Stocks and bonds often pay interest or dividends which are distributed among investors. This is the most common way that investors earn with a mutual fund.

  • Increase in share price. When the stocks in the mutual increase in value, the share price increases and you can sell your investments for cash at a profit.

  • Capital gains. Capital gains are distributed to investors annually. These gains are taxed as income produced when the mutual fund sells its shares for a higher price than they originally paid.

Should you invest in mutual funds?

Whether or not you should invest in mutual funds is highly dependent on your goals as an investor and your time horizon for when you want to see the returns. Mutual fund investing may be ideal for people who are settled in their careers and want a stable long-term investment that will guarantee to increase in value by the time of retirement.

Other considerations before investing in mutual funds

If you still want to invest in mutual funds, there are several other considerations you should take into account before calling a mutual fund company and opening an account.

  • Investment management style. Mutual funds require active management while other investments like index funds are passive and mimic the trend of common index funds.

  • Performance. Those looking for investments with the potential for outsized returns may want to look elsewhere. Mutual funds are generally considered a safe investment but won’t help generate big returns like hedge funds.

  • How much experience does the fund manager have? You should ideally choose a mutual fund where the fund manager has a track record of success in the industry from managing other funds. While everyone needs to get their start somewhere, you don’t want to trust a beginner with your retirement nest egg.

  • Taxes. There are many different tax considerations to take into account before investing in mutual funds. You should be familiar with the benefits and ways you can use mutual fund losses as tax write-offs to reduce your taxable income and pay less in taxes at the end of the year.

Final thoughts

Knowing the benefits of mutual funds and their drawbacks can help you make a smart decision on the future of your financial health. Investing in mutual funds can be a great way to diversify your portfolio and generate consist and stable returns over the years.

However, mutual funds certainly aren’t the right choice for everyone. Entrepreneurs typically don’t benefit as much from mutual fund investing since they need liquid cash to sustain their business as they’re just getting started. Other drawbacks to mutual funds include paying high fees for being in the fund and not having losses insured by the FDIC.

Are you looking to get your investing career started? Check out the best real estate investing strategies you can use to build generational wealth in real estate today.

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Table of Contents
  1. What is a mutual fund?
  2. Types of mutual funds
    1. Money market funds
    2. Stock funds
    3. Target-date funds
    4. Bond funds
  3. Benefits of mutual funds
  4. Drawbacks of mutual funds
  5. Mutual fund managers
  6. How to earn with mutual funds
  7. Should you invest in mutual funds?
  8. Other considerations before investing in mutual funds
  9. Final thoughts