What are Mutual Funds Disadvantages?
While low risk mutual funds are an important part of many asset management strategies, they are not a panacea for investors. Every successful portfolio has the intention of using the best mutual fund they can find to meet the investor’s global tactical asset allocation strategy for diversification and to maximize returns. This edition of our investment management blog addresses the disadvantages of mutual funds.
1. What are Mutual Funds Insurance Protection?
Mutual funds are regulated by the Securities and Exchange Commission (SEC), but the government does not guarantee the investment, the returns, or the principle. While rare, it is possible to lose your entire principal, even in low risk mutual funds. Investments made through banks, such as CD’s, are covered by the Federal Deposit Insurance Corporation (FDIC), which protects deposits up to $250,000.
2. What are Mutual Funds Diversification?
Diversifying your portfolio is one of the best ways to reduce risk. However, it can lead to dilution of your investment. Say your mutual fund owns INTC stock and it suddenly doubles in value. However, your mutual fund won’t double in value since INTC stock is only one investment in the fund. This is a situation in which low volatility mutual funds as part of a tactical asset allocation group is an advantage. By using an asset allocation strategy with several different investments, the performance of mutual funds isn’t the single indicator of the overall performance of your portfolio.
3. What are Mutual Funds’ Performance Expectations?
As previously mentioned, mutual funds, including low risk mutual funds and the best mutual fund on the planet, don’t have a guaranteed return on your investment. On average, the results are awful as 82% of mutual funds don’t beat the major indexes (like the S&P 500) on returns over the long term. Specifically, CNN executed a study over the last 10 years citing 82% of funds under-performed the Market returns. This is mostly due to their over-diversification combined with their fees and transaction costs, but there are great low risk mutual funds out there that consistently outperform the major indexes if you know where to look that do that are great as part of a tactical allocation group of investments can overcome the investment decisions made by the investment management company.
4. What are Mutual Funds Fees and Expenses?
Nearly every mutual fund, even the low volatility mutual funds, charge the investor expenses and fees that cover the costs of the funds expenses. These fees can range between 1.0% and 1.5% annually. Many investment management companies also charge commission fees, 12b-1 fees and fees to redeem shares. Funds that frequently trade investments can also wrack up transaction charges which are passed on to investors.
5. You Lose Control of Important Decisions
The investment management company makes all decisions regarding which stocks, bonds or other securities to purchase and sell within the fund. When someone else makes the decisions, it might not mesh well with your tactical investment allocation models, your tax goals, or other investments that you may have outside of the fund. The fund manager of even the best mutual fund simply cannot take your personal situation into consideration when making investment decisions.
6. What are Mutual Funds Trading Limitations?
Although the worst and best mutual funds are usually considered to be liquid, generally they are only able to be traded after the market closes for the day, when the prices for the fund are established, limiting their overall liquidity.
7. What are Mutual Funds’ Size Limitations?
One of the biggest problems for the top and best mutual funds is that everyone wants to give them money to invest, but once a mutual fund reaches a certain size it can be difficult to for it to add investments. Small cap funds, or those that focus on business with capitalization of $300 million to $2 billion, can be particularly vulnerable. Often times the fund management has strict rules for how much ownership a mutual fund can have in a single company. If the fund has $5 billion to invest to meet the asset management strategies of the fund, it may only be able to purchase $30 million shares to avoid problems. Unfortunately, this type of capital investment management strategy can cause the investment management company to broaden their requirements for companies to invest in. This means that the some companies may not be as financially stable or well managed as others.
8. What are Mutual Funds Efficiencies of Cash Reserves?
All funds, even the best of the best mutual fund, generally maintain a fairly large cash reserve to hedge against a run of withdrawals on the fund that can range from 3-20% of the assets held under fund management. While it’s nice for the fund to have liquid assets for investors as one of its investment management solutions, it also means that a significant amount of the fund’s assets aren’t being invested for growth. This can translate into lower returns for investors and ultimately investors lose control over how the cash reserves are managed.
These disadvantages apply to all mutual funds. There are currently over 10,000 mutual funds which differ in asset management strategy, capital investment management style, and size. Using a low risk mutual fund help meet your tactical asset allocation goals since they are available for nearly every investment sector. Our investment managers can help you find the best one for you.
If you have an interest in getting an expert evaluate your mutual funds to show you the risks that you have and compare them to other possibilities that may work well with your investment strategies, contact us at (888) 938-5872 and we can show you a few pretty interesting things; like funds that did not lose money in 2001 and 2008