Pros And Cons Of Mutual Fund Investing
Mutual funds are a great investment, especially for beginner investors. But they also have the potential to suck your investment portfolio dry, so let's go over the pros and cons to prevent that from happening to your nest egg.
- They reduce risk because they are diversified
- Dividends are automatically reinvested
- You don't need much money to start investing in them
- Management fees can be high but are avoidable
- Taxes can be high but you can eliminate them
- 60% of them don't outperform the S&P 500
Fortunately, every single one of the disadvantages is surmountable.
How To Avoid Paying High Management Fees
To avoid paying high fees you need to invest in an index fund. I recommend an S&P 500 index fund like this one from Charles Schwab because it has a paltry yearly fee and there's no minimum dollar amount to start investing.
How To Avoid Paying Taxes
Most mutual funds pay a dividend a few times a year. The dividend is usually automatically reinvested but you still have to pay taxes on it even though it didn't go into your pocket.
The easiest way to avoid paying taxes on dividends is to open an IRA. An IRA is a retirement savings account that you can use to buy mutual funds with. Any dividends you earn will not be taxed and the same goes for any earnings you get when you decide to sell the fund.
How To Outperform The S&P 500
The S&P 500 invests in 500 of the largest companies in the United States. While that makes it a well diversified collection of stocks, a slightly more diversified brokerage account will almost always outperform the S&P 500 over the long haul.
Portfolios that invest 10% of their holdings in bonds and the other 90% in the S&P have historically earned more than portfolios that were 100% invested in the S&P 500. The same goes for investing the other 10% in emerging market funds.
Of course you can buy individual stocks too but that's much riskier than adding a little diversification to your portfolio with a small position in bonds or emerging markets.