4 Common Myths About Mutual Funds You Should Know Before Investing
Written by
Karen Doyle
Edited by
T. Woods
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Mutual funds are a popular way to invest, and if you have a 401(k) or other workplace retirement plan, you probably own some. But mutual funds can be misunderstood. Here are four common myths about mutual funds that you should know.
1. Mutual Funds Are Diversified
While they are certainly more diversified than individual stocks, dumping all your assets into a single mutual fund does not a diversified portfolio make. It’s true that a mutual fund is made up of a ‘basket’ of stocks, and when you buy a share of a mutual fund, you are buying a tiny bit of each of the stocks in that basket.
In most cases, however, the stocks in that basket are not diversified. For example, the top ten holdings in the Fidelity Select Technology fund (FSPTX), representing over 75% of the total holdings, are all technology companies.
Some mutual funds are more diversified than others, of course. But a truly diversified portfolio will include bonds, cash, and other investments in addition to mutual funds.
2. Mutual Funds Can Help You Beat The Market
The whole idea behind mutual funds is to take volatility off the table. A sector-based mutual fund, such as one that focuses on technology or consumer packaged goods, for example, will perform similarly to the sector as a whole. An index mutual fund will mirror the performance of an index, like the S&P 500 or the Russell 2000. So you will not beat the market by buying these mutual funds, but you will match it — or at least come close.
3. Mutual Funds Have High Fees
Mutual funds do have fees, but they are not as high as conventional wisdom would assume. The introduction of exchange traded funds, which have very low fees, has put downward pressure on mutual fund fees, and many funds have fees under 1%.
One advantage to some mutual funds is that they are professionally managed, and the fund manager buys and sells positions in order to maintain the fund’s performance. If you were to try to do with in your own portfolio – buying and selling individual stocks in order to keep your asset allocation in balance and maximize your returns — you would likely pay far more in transaction and other fees.
4. Buying Only Mutual Funds is a Good Investment Strategy
Putting all your money in mutual funds may be a better strategy than putting it all into a single stock, but it still shouldn’t be your entire investment strategy. You should also have some money in bonds, cash, and even alternative investments if you’re feeling a little risky. A well-balanced portfolio can weather a lot of economic storms, and, while mutual funds are a good start, they shouldn’t comprise your entire investment portfolio.
Understanding mutual funds can make you a better investor and is a good first step. Take the time to do some research on the particular funds you are considering, and on any other investments that you’re thinking of adding to your portfolio. The more you know, the better and more comfortable an investor you will be.
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