Mutual Funds are not free from criticism. Beyond many advantages one should also know the disadvantages of Mutual Funds also. So before buying, we should we explore some of the drawbacks or disadvantages of mutual funds.
1. Fluctuating or Volatile Returns:
Like other investments, investments in Mutual funds are of unguaranteed return. Due to volatile market conditions there is always a possibility of reduction (depreciation) in the value of your mutual fund. It is not fixed-income products like bonds or treasury bills. Mutual funds are prone to price fluctuations along with the stocks that make up the fund. So before buying a particular fund, risk analysis is a must job. In the USA, mutual funds are not guaranteed by the government, so in the case of liquidation or dissolution, you won’t get anything in return. So be aware of disadvantages of mutual funds.
Another disadvantages of mutual funds is many mutual fund investors are likely to over-diversify their business. Over-diversification is otherwise known as diworsification. The thought of diversification is to shrink the risks associated with investing in a single security. Again, if you hold mutual funds, it doesn’t mean that you are automatically diversified.
3. Different Types of Fees:
Mutual Funds generally have different types of fees; in broad: shareholder fees and annual fund operating fees, which shrink the overall payout. The shareholder fees are paid by shareholders while purchasing or selling the funds, in the forms of loads and redemption fees. The fund operating fees are assessed annually in a percentage around 1-3%. These fees are charged against investors of the fund irrespective of the performance or yield growth of the fund.
4. More Idle Cash:
Mutual funds collect money from thousands of investors. It is usual that investors are keeping money into the fund and withdrawing investments (banking type). In order to maintain the liquidity, mutual funds normally have to retain a large share of their collections as cash to accommodate withdrawals which can be compared to non-performing work-in capital or idle cash. So this is one of the disadvantages of mutual funds.
5. Appraising Funds:
Additional one of the disadvantages of mutual funds is the difficulty in researching and appraising different funds in a line. Mutual funds do not give investors, the data related to P/E ratio, sales growth, EPS, etc like other common shares in Stock Exchange. Net asset value of mutual funds provides total value of the fund’s portfolio less liabilities to the investors but is it enough data to compare and know which fund is better than another?
The misleading advertisements of many mutual funds direct the investors towards the wrong track. The SEC necessitates funds to retain at least 80% of assets in the specific type of investment implied in their names. The asset categories of funds to qualify for the required 80% of specific assets may be vague and wide-ranging. So, funds have chances to manipulate prospective investors by using names that are eye-catching and misleading.
Before buying any investment, it is imperative to understand both the pros and cons. If the advantages are more than the disadvantages, it is quite feasible that mutual funds are something to consider for investments. But disadvantages of mutual funds should be critically analyzed.