Risks and Advantages of Investing in Mutual Funds

A mutual fund is a type of investment device that groups together money from a pool of investors, using this money to buy an assortment of stocks and bonds.

Most mutual funds purchase a variety of stocks and bonds, but adhere to a general theme, such as only investing in technological companies.

By selecting a number of different stocks and bonds, which are purchased under the authority of the mutual fund managers, the goal is to help to spread out, or diversify, the risk among the different investments.

Generally in regards to stocks, diversification works out better in the long run, as opposed to simply putting all of a persons money in one place, with the idea being that no one poorly preforming stock will bring the entire stock portfolio down.

In addition to offering the advantage of having more money to work with, as each investment adds to the mutual fund, another major advantage is that there are a group of professionals in charge of the mutual fund. This means that the average member of the fund does not need to know the nitty gritty of investing, instead letting the mutual fund managers make the actual purchase decisions. Of course, a hands off like this can and does backfire, but in most cases, the management of the mutual fund is better trained than the average investor.

Risks of Investing in a Mutual Fund

As with any type of investment, there are some risks when investing in a mutual fund.

One of the most common risks on a persons mind when they make an investment is that they may loose money, which is a legitimate concern with a mutual fund. Loosing money can occur when the stocks purchased by the mutual fund loose value.

In practice, a mutual fund does not invest in only a single stock, but a variety of stocks, which is intended to offset this risk. This way, any one or two poorly preforming stocks will not cripple the mutual fund.

While diversification can help to mitigate risk, there is always the risk of loosing money due to deprecation in value of a mutual fund. However, often these losses are only in the short run, as in many cases, when you look at the performance of a mutual fund over 10 or 20 years, it will usually show adequate returns.

Inflation is another risk, which is caused when the value of the dollar decreases, causing prices to increase. If inflation occurs, the value of the stock must also increase at the same or greater rate, otherwise even though on paper you might not have technically lost money, you are in fact loosing purchasing power.

As is alluded above, it is important to remember that on a daily, weekly, monthly, and even yearly basis, you are likely to see rises and falls in the value of the mutual fund. This is normal and usually it is not advised to look at a mutual fund as a short term investment, instead looking at the long term returns of the mutual fund. When you factor in taxes, it is much easier to see why many mutual funds are a more attractive long term investment than a short term one.

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