So why would I recommend that investors also participate in mutual funds? Because they offer several advantages: - Diversification. The risk of owning a whole portfolio of stocks is considerably less than the risk of holding any one individual stock. But it can take quite a bit of money to build a diversified portfolio of stocks or bonds. You get instant diversification with each mutual fund share.
- Professional management. Whether you own an index fund or an actively managed fund, there is a professional manager overseeing the portfolio.
- Low minimums. Each fund establishes its own investment minimum. But minimums have come down dramatically over the past few years. And ETFs have no investment minimums.
- No financial advisor required. You can buy mutual funds that charge no loads (commissions) directly from the fund companies.
- Liquidity. Mutual fund companies will allow you to redeem (sell) all or part of your shares on any day the market is open for trading. ETFs can be sold at market on any day the market is open.
- Automatic reinvestment. You can arrange for all your fund's dividends and capital gains to be automatically reinvested in the fund - or directed to other funds - without charge.
- Convenience. You can buy and redeem fund shares online, by phone, or by mail. You can arrange automatic purchases from your bank account, or you can arrange regular periodic withdrawals. You can also arrange that the proceeds from your funds' redemptions or distributions be deposited in your bank account.
- Simplified record keeping. You will receive regular statements showing the value of your account and any activity. At the end of each year, you'll receive the tax- reporting information you need, too.
- Customer service. If you have a question or a problem, or need to make changes to your account, you can call your fund's toll-free customer service line and get the help you need at no additional cost.
- Time. Owning shares of a mutual fund saves you the trouble of researching, constructing and monitoring a portfolio of individual stocks.
There are essentially two types of mutual funds: index funds and actively managed funds: - Index funds. With these, the fund manager attempts to replicate the return of a particular benchmark, such as the S&P 500 or the Bloomberg Barclays Aggregate Bond Index. Index fund managers generally do not buy stocks or bonds that are not included in the benchmark.
- Actively managed funds. Active managers try to outperform a benchmark by selecting the best-performing securities or trying to time the market. Or both.
Some readers may question why any investor would settle for the performance of an index when you can opt for a fund manager who will swing for the fences. The answer is because most of them strike out. You may not realize just how exceptional - and rare - great managers are. Investing in actively managed funds is generally an exercise in futility. In any given year, about three-quarters of all equity fund managers underperform. Over periods of 10 years or more, over 90% of them do. Why would you pay higher fees for less than a one-in-ten chance of long-term outperformance? You wouldn't... if you knew the truth. If you're going to invest in index funds, the best choice is Vanguard. The average Vanguard mutual fund and ETF expense ratio is 82% less than the industry average. That's because Vanguard is a not-for-profit corporation. The fund company is actually owned by the fund shareholders. That means everything is run at cost. And with Vanguard, you know exactly what you're getting. Vanguard stock and bond funds stay fully invested in their target markets. Their managers do not try to time the market. Vanguard does not advertise its funds' past returns or peer rankings, which are based on past performance and can mislead investors. In short, the interests of Vanguard shareholders and fund managers are completely aligned. That means lower fees, less hassle, no sales pressure and higher net returns. However, this month the case for investing in Vanguard funds became even more compelling. And in Monday's column, I'll explain why. Good investing, Alex |
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