MUTUALLY BENEFICIAL Investing in mutual funds is a simple way for new investors to get into the market. What started as obscure financial instrument has become extremely popular over the last 20 years and given birth to the whole financial planning industry. We see them sold in just about every bank, insurance company, and investment agency. They’re packaged as part of savings plans; insurance plans and come in so many different “flavors.”
But although they are more accessible to the average person than individual stocks, they still require research and knowledge. That’s where most people who’ve lost money in mutual funds fail. They’ve been led to believe that mutual funds are secure, low-risk, and returns are almost guaranteed. The financial downturn in 2008 showed, like any other investment, how uncertain they can be. Instead of finding out everything they can about the mutual fund they planned to invest in, they left it to someone else.
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There’s always going to be supporters and detractors of including mutual funds in your investment portfolio. The key is not to blindly follow advice, but like ANY investment opportunity, you have to do your own homework before you invest. Returns Mutual funds are like many other investments without a guaranteed return: there is always the possibility that the value of your mutual fund will depreciate.
Unlike fixed-income products, such as bonds and Treasury bills, mutual funds experience price fluctuations along with the stocks that make up the fund. When deciding on a particular fund to buy, you need to research the risks involved – just because a professional manager is looking after the fund, doesn’t guarantee good performance. That’s largely dependent on the skill of the Fund Manager in picking winning investments. Another major case in point: mutual fund returns are not guaranteed by the Monetary Authority of Singapore, so in the case of dissolution, you won’t get anything back. Also, unlike a bank deposit, a mutual fund is not insured, and unlike traditional stocks, you can’t set a stop-loss to protect yourself. Advertising The first thing you need to be aware of is to ignore the pretty brochures and attractive advertising. Some funds may be incorrectly labeled and can therefore manipulate prospective investors by using names that “sound nice.” Instead of labeling itself a small cap, a fund may be sold as a “growth fund”. Or, the “Zimbabwe High-Tech Fund” could be sold with the title “International High-Tech Fund”.
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Diversification Diversification is touted as one of the advantages of mutual funds but many fund investors tend to over-diversify. Warren Buffett’s belief is over-diversification can hamper returns as much as a lack of diversification. That’s why he doesn’t invest in mutual funds. It’s also why he prefers to make significant investments in just a handful of companies.
The reverse is also true if investors acquire many funds that are highly related and, obviously, don’t get the risk reducing benefits of diversification. If a fund invests only in a particular industry or region it is still relatively risky. Fees Mutual funds provide investors with professional management, but by allowing you to take a hands-off approach to investing comes at a cost. You pay operating fees charged as an annual percentage – usually ranging from 1-3%. You’ll also pay fees for purchasing or selling the funds. These are fees you have to pay regardless of the performance of the fund. This means that even if your fund doesn’t make any money, you’ll still have to pay the fees.
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Summary As with any investment, it’s important to understand and weigh both the pros and cons. It doesn’t matter which investment you decide to add to your portfolio, the best protection for your investments is education. The more you know about an investment, the more thorough your due diligence, the higher your probability of success.
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