As financial advisers and money managers, we generally prefer to invest clients’ money using individual stock holdings to create a portfolio. We often recommend that investors own 10 to 16 different stocks in at least six to eight sectors of the market. However, for those who are just beginning to invest or those who have less than $50,000 invested, mutual funds can provide instant diversification, professional portfolio management and exposure to sectors or holdings that are difficult to research.
Mutual funds pool together money from multiple investors and invest it in stocks, bonds, cash-like instruments and even futures and options. Mutual funds can be modeled after a particular index, like the S&P 500, or specialize on specific sectors or asset classes, like Small-Cap or International stocks. You may be most familiar with asset class based funds in your 401(k). Funds can also have objectives, like capital appreciation or dividend income.
When you purchase shares of a mutual fund, you are buying a unit of the whole portfolio in an affordable way. You may easily have exposure to 20 to 50 stocks in one mutual fund. If you are a beginning investor, and you are investing $500 a month, how much stock can you really buy? Remember, no one stock should be more than 10% of your total portfolio. By purchasing shares of an index mutual fund you can achieve instant diversification in several stocks across different sectors.
Exchange-traded funds (ETF) are similar to mutual funds in that you are purchasing a unit of a basket of securities, but ETFs are often passively managed, designed to track a particular index or sector. They mirror the holdings and weightings of a particular benchmark; therefore, your performance should mirror the index as well.
Mutual funds, on the other hand, generally have active managers, meaning there are professionals, backed by a research team, that review individual holdings in the fund, and can decide to underweight or overweight a particular holding or sector as compared to an index. With actively managed mutual funds, you may outperform the market indices; however, mutual funds can also underperform as well. Of course, this professional management comes at a price that must be paid from fund assets. These costs are incurred through marketing, advisory fees, accountants’ fees, legal fees, custodial fees, etc. Simple transactions such as buying, selling and exchanging shares can be costly for mutual fund companies as well. The investor is the one who inevitably pays for these costs. As a novice investor, these fees for professional management may be worth the expense.
Mutual fund investors also have less control of their tax situation than investors who own a portfolio of individual stocks. Mutual funds generate income on their investment portfolios from dividends paid by the underlying stocks, interest from the underlying bonds, or net capital gains realized from turnover in the fund’s investments. Dividend income may be paid monthly, quarterly or annually. Capital gains are generally distributed in December. If you are purchasing shares of a mutual fund in a taxable brokerage account, you should be aware of the timing when you buy shares toward the end of the year, with regard to dividend payments and capital gain distribution dates. All investors who own shares as of the close of business on the record date are entitled to receive distributions. It does not matter if you bought the shares one day or 10 years prior to the distribution. When you hold fund shares in a taxable account, you are taxed on the payout.
Choosing your investments is an important decision for all investors. If you have a limited amount of funds to invest, mutual funds may be beneficial because they can provide exposure to a wider range of investments. If you have questions regarding how you may benefit from using mutual funds as an investment, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
