DELVING INTO FIVE SECRETS OF MUTUAL FUNDS

ETFs as Better Investment Options

In most cases, fund managers fail to explain the difference between exchange-traded funds and mutual funds in terms of structure. ETFs provide greater liquidity and its shares are freely traded throughout the day on major exchanges. On the other hand, mutual funds can be bought or sold at its net asset value or NAV price. ETFs also create fewer taxable capital gains events for investors. However, for mutual funds, investors who never sell any of his shares are still obliged to pay taxes.

Fees Charge More than We Think

Many investors simply ignore the 1% expense ratio as they believe that fee is only reduced from the total amount of generated profit. But it works the other way around as the expense ratio is deducted from an investor’s total capital. For example, if an investor places $10,000 in a mutual fund with a 1% expense ratio, the annual fee is $100. Let’s say the fund earns 10% profit for the year, the investor earns $1,000. Conversely, if the fund generates only 2% profit for the year, the 1% fee takes half of the investor’s profits.

Investing in Top Funds Do Not Work

Perhaps in stocks, but not in mutual funds. This mindset overlooks the fact investments are cyclical in nature. When a fund performs well this year, it might be down the following year, and vice versa. A Standard & Poor study showed less than 10% of the leading funds in 2012 were even included in the top 25% of funds by 2014. Fewer than 1% of the previous top performers remained in the top 25% of mutual fund rankings after five years.

Actively Managed Funds are Index Funds in Disguise

Recent studies show numerous actively managed funds are index funds in reality. Two studies, conducted in 2009 and 2013, looked into 20 years’ worth of mutual fund data, which indicated there was a huge increase in closet index from 10% to almost 30%. The fund manager’s active stock selections mirror the benchmark index’s selections, and its portfolio has minimal difference from index funds. Since the fees for actively managed funds can be 10 to 20 times higher than for an index fund, investors need to ensure they are actually getting the active management services for which they are paying.

Mutual Funds Can Provide a More Efficient Means of Investing

This is a good secret, though. What makes mutual funds appealing is it enables the purchase of partial shares. Let’s presume John has a personal financial plan and contributes $100 a month to investing. If he desires to buy individual stocks being sold at $60 a share, he has to allocate more than half of his monthly investment to do so until he can set aside enough capital to purchase another share. That scheme delays his investment, not to mention it can cost him money should the stock price rise from $60 to $80 the following month. Mutual funds, referring to this example, allows him to obtain partial shares so he can invest his $100 contribution without any delay or problem.