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Mutual Funds - Essay Example

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With the increasing risk of the financial markets brought on by the American recession and the European Sovereign Debt Crisis investors have increasingly looked to safe havens for their money. …
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Mutual Funds
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Mutual Funds

Mutual funds are securities that are registered with the Securities and Exchange Commission (SEC). Broadly speaking, they are composed of stocks, bonds, short-term money market instruments, and other securities that function as a means of hedging against possible declines in a security or investment sector. The main understanding is that this diversified approach will provide the investor an option that protects them against market fluctuations, as when one security drops in value, another will increase. A manager or board of directors oversees these funds. The board hires a fund manager and works to ensure that the mutual fund is managed in the intended interest of the shareholders. This essay examines the advantages, disadvantages, and different types of mutual funds. Advantages There are a great variety of advantages to investing in mutual funds. One of the most prominent such aspects is the increased amount of diversification. In terms of portfolio theory, diversification constitutes perhaps the most overarching concept. Essentially diversification is the gathering together of diverse investment securities as a means of guarding against the failure of one specific sector. While it is possible for investors to diversify their portfolio through a widespread purchase of stocks, such a process is both extensive and also contains liquidity issues. In terms of liquidity, most brokerage firms attach a fee to individual trades, such that an individual attempting to withdraw money from a portfolio of diversified stocks would be required to pay a series of fees; mutual funds offer liquidity in terms of one direct and easily accomplished sale (Pozen, Hamacher, 2011). Another prominent advantage of mutual funds is that they operate in terms of economies of scale. Essentially the equivalent of economies of scale is volume discounts in department stores. In the context of mutual funds, a wide variety of investment funds are collated allowing the fund manager to gain greater value per purchase (Pozen, Hamacher, 2011). Divisibility is another prominent advantage to investing in mutual funds. Divisibility can be understood in terms of the purchase of a wide variety of stocks. It’s noted that, “Smaller denominations of mutual funds provide mutual fund investors the ability to make periodic investments through monthly purchase plans while taking advantage of dollar-cost averaging” ("Advantages of mutual," 2009). Essentially this indicates that through a mutual fund, an individual with modest means is able to invest in a great amount more stocks than they would if they only purchased the securities on their own. This allows for considerably greater amounts of diversification. Another prominent benefit of investing in mutual funds is that they are under professional management. The obvious implications of this are that an experienced and knowledgeable professional will be overseeing the securities and investment strategy. Ultimately, the cumulative advantage of these benefits makes mutual funds an attractive option for conservative or inexperienced investors. Disadvantages While there are a great variety of advantages to investing in mutual funds, there are also a number of prominent disadvantages. Even as mutual funds offer a generally conservative investment option as compared to stocks, precious metals, or derivatives, there is nonetheless a degree of risk associated. The main understanding in these regards is that even with extensive levels of diversification, macroeconomic elements oftentimes contribute to a large-scale market decline. In these regards, individuals that do not have the financial wealth or patience to out-wait market downturns might find mutual funds an unattractive option ... Read More
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