Like all investments, mutual funds come with a set of advantages as well as some drawbacks. These disadvantages may not mean much to you, but you need to be aware of them nevertheless before you make the decision of investing capital. Below we have outlined a number mutual funds disadvantages for you to look out for.
1. Inconsistent dividends
The first mutual funds disadvantage is inconsistent dividends. Similar to various other investments that come without a promise of assured returns, when you invest in mutual funds you need to be open to the possibility that your fund’s value may depreciate. Since mutual funds are made up of shares, their price will fluctuate as the stock value fluctuates. Before purchasing any kind of funds, you need to be aware of the risks associated with that particular fund. An experienced manager with a good track record may efficiently manage the fund, but there is no guarantee that the fund’s performance will be exceptional.
Another consideration to keep in mind is that the US government does not guarantee mutual funds, and unlike the funds you hold in your bank account, mutual funds are not insured by the FDIC, which means that if the funds dissolve for whatever reason, you will lose your investment with no chances of compensation.
2. Over-diversification
Seasoned investors know diversification to be the key to a successful trade, but many investors, especially those without much experience, often over-diversify. The main purpose of diversification is to hold your funds in various investments of different kinds to spread your capital and reduce risks associated with holding all capital in a single fund. Over-diversification is when investors invest in various funds that are closely related, thus eliminating any hope of reducing investment risk.
Additionally, some investors believe that because they hold mutual funds, they are consequently diversified, which is incorrect. If a fund makes investments in a single industry or in a single region, it increases the associated risk.
3. Dormant cash
As all prospective investors will be aware, mutual funds are invested in by a number of other investors which means that capital is being put into the funds every day as well as being withdrawn. This is where another mutual funds disadvantage comes into light. To be able to entertain withdrawal requests, funds have to hold a considerable proportion of the portfolio as cash, which can prove to be disadvantageous as this money is not being invested.
4. Fees and expenses
Mutual funds professionally manage your investments but there are costs involved. All funds will charge an annual management expense, that can be anywhere between 0.1% to 3% of your original investment, along with other fees and charges. Some funds will charge a load fee which is forwarded to the brokers, while others may be load-free but will still charge other operational, selling, and advertising charges for your funds. All these fees will considerably reduce your expected returns, therefore funds and their fees structure and rates need to be assessed before making an investment.
5. Ambiguous or deceptive advertising
To attract investors, some funds may resort to deceptive advertising and mislead investors. This is quite an obvious mutual funds disadvantage. They do this by incorrectly labelling funds. Some might be mislabeled as growth funds while others may be advertised as income funds. The SEC demands that at least 80% of the assets held in a particular investment must be in the fund’s name. The remaining can be invested at the manager’s discretion.
6. Lack of assessment opportunities
Mutual funds do not offer much assessment and evaluation opportunity as investors can’t compare P/E ratios, earnings per share, and growth ratios of the funds they are considering. Investors can view the fund’s net asset value, which will indicate the total assets in its portfolio but does not shed much light on its profitability in comparison to other funds.
Before investing in, it is vital that you carry out detailed assessment to understand the mutual funds disadvantages. If your results indicate that the disadvantages or risks associated with the investment overshadow the advantages, you should steer clear and opt for investing your capital in funds that offer the opposite.
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