Like many investments, mutual funds offer advantages and disadvantages, which are important for you to consider and understand before you decide to buy. Here we explore some of the drawbacks of mutual funds
- Mutual funds have hidden fees –
If fees were hidden, those hidden fees would certainly be on the list of disadvantages of mutual funds. The hidden fees that are lamented are properly referred to as 12b-1 fees. While these 12b-1 fees are no fun to pay, they are not hidden. The fee is disclosed in the mutual fund prospectus and can be found on the mutual funds’ websites. Many mutual funds do not charge a 12b-1 fee. If you find the 12b-1 fee onerous, invest in a mutual fund that does not charge the fee. Hidden fees cannot make the list of disadvantages of mutual funds because they are not hidden and there are thousands of mutual funds that do not charge 12b-1 fees.
- No Insurance –
mutual fund, Although regulated by the government, are not insured against losses. the federal deposit insurance corporation (FDIC) only insurers against certain losses at banks, credit unions and savings and loans, not mutual funds. That means that despite the risk-reducing diversification benefits provided by mutual funds, losses can occur, and it is possible ( although extremely unlikely) that you could even lose your entire investment
- Mutual Funds Lack Liquidity –
How fast can you get your money if you sell a mutual fund as compared to ETFs, stocks and closed-end funds? If you sell a mutual fund, you have access to your cash the day after the sale. ETFs, stocks and closed-end funds require you to wait three days after you sell the investment. I would call the “lack of liquidity” disadvantage of mutual funds a myth. You can only find more liquidity if you invest in your mattress.
- Dilution-
Although diversification reduces the amount of risk involved in investing in mutual funds, it can also be a disadvantage due to dilution. For example, if a single security held by mutual fund doubles in value, the mutual fund itself would not double in value because that security is only one small part of the fund’s holdings. By holding a large number of different investments, mutual funds tend to do neither exceptionally well nor exceptionally poorly.
- Mutual Funds Have High Sales Charges-
Should a sales charge be included in the disadvantages of mutual funds list? It’s difficult to justify paying a sales charge when you have a plethora of no-load mutual funds. But, then again, it’s difficult to say that a sales charge is a
disadvantage of mutual funds when you have thousands of mutual fund options that do not have sales charges. Sales charges are too broad to be included on my list of
disadvantages of mutual funds.
- Fees and expenses –
Most mutual funds charge management and operating fees that pay for the fund’s management expenses (usually around 1.0% to 1.5% per year for actively managed funds). In addition, some mutual funds charge high sales commissions, 12b-1 fees, and redemption fees. And some funds buy and trade shares so often that the transaction costs add up significantly. Some of these expenses are charged on an ongoing basis, unlike stock investments, for which a commission is paid only when you buy and sell.
- Poor Performance-
Returns on a mutual fund are by no means guaranteed. In fact, on average, around 75% of all mutual funds fail to beat the major market indexes, like the S&P 500, and a growing number of critics now question whether or not professional money managers have better stock-picking capabilities than the average investor.
- All Mutual Funds Have High Capital Gains Distributions-
If all mutual funds sell holdings and pass the capital gains on to investors as a taxable event, then we have a found a winner for the list of disadvantages of a mutual funds list.
Oh well, not all mutual funds make annual capital gains distributions. Index mutual funds and tax-efficient mutual funds do not make these distributions every year. Yes, if they have the gains, they must distribute the gains to shareholders. However, many mutual funds (including index mutual funds and tax-efficient mutual funds) are low-turnover funds and do not make capital gains distributions on an annual basis.
In addition, retirement plans (IRAs, 401ks, etc.) are not impacted by capital gains distributions. There are also strategies to avoid the capital gains distributions including tax-loss harvesting and selling a mutual fund prior to the distribution.
- Loss of Control-
The managers of mutual funds make all of the decisions about which securities to buy and sell and when to do so. This can make it difficult for you when trying to manage your portfolio. For example, the tax consequences of a decision by the manager to buy or sell an asset at a certain time might not be optimal for you. You also should remember that you are trusting someone else with your money when you invest in a mutual fund. Misleading Advertisements
- Misleading Advertisements-
The misleading advertisements of different funds can guide investors down the wrong path. Some funds may be incorrectly labeled as growth funds, while others are classified as small-cap or income. The SEC requires funds to have at least 80% of assets in the particular type of investment implied in their names. The remaining assets are at the discretion solely of the fund manager.
The different categories that qualify for the required 80% of the assets, however, may be vague and wide-ranging. A fund can, therefore, manipulate prospective investors by using names that are attractive and misleading. Instead of labeling itself a small cap, a fund may be sold under the heading growth fund. Or, the “Congo High-Tech Fund” could be sold with the title “International High-Tech Fund”.
- MUTUAL FUND ARE SUBJECT TO MARKET RISK – MUTUAL FUND INVESTMENT ARE SUBJECT TO MARKET RISK INVOLVED. THIS CAUTION ( WARNING ) CAN BE CHECKED with the offer document where it is clearly mentioned as follows ;
“ Mutual Fund investments are subject to market risks. Please read the offer document carefully before investing.”
12 .Selecting right financial securities is not easy – it’s difficult task for a mutual fund manager to select appropriate and suitable financial securities for investment to generate higher returns.
conclusion-There would be certain disadvantages of investing in almost all investment-prospects. However, in case of mutual funds, the risk of disadvantages can be mitigated (reduced) by preparing a list of its limitations.
Once such a list is prepared, then each item (disadvantage) in the list shall be scrutinized and determined to decide whether it applies as a
disadvantage of the mutual fund or to a particular scheme of it.
