Are Mutual Funds a Good Investment?

December 19, 2022 Michael Iachini
Mutual funds may be a good investment for anyone looking for diversification in their portfolios. Learn whether mutual funds can be the right investment for you.

Mutual funds offer diversification and convenience at a low cost, but whether to invest in them depends on your individual situation. Here's what to consider when thinking about using mutual funds to potentially grow and help protect your savings.

Why Choose Mutual Funds?

Diversification

Investing in just a handful of stocks can leave you exposed to what is called "overconcentration." When one or two stocks that represent a sizable portion of your savings decline, it can have an undue influence on your investment performance. Mutual funds help provide instant diversification since they invest across dozens or sometimes hundreds of individual stocks, bonds, or other securities.

Further, history shows that large groups of stocks tend to ride out market volatility better than individual stocks. For example, when the market is volatile, one poor performing stock may be smoothed out by other stocks that are performing well in the same index, which may help reduce the risk to your overall portfolio than if you were invested in only one stock.

Access to different markets

Exposure to different asset classes can help provide another level of diversification since their prices generally don't move in lockstep. When you invest in just one part of the market—say, U.S. technology stocks—you are at increased risk that bad news involving the sector will sink your results. You might also need an investment to serve a specific role in your portfolio, such as generating income or adding stability during periods of market duress.

Mutual funds can provide access to many different parts of the market, even within the broad asset classes of stocks and bonds. Within stocks you can invest in large or small companies, those focused on growth or paying out dividends, and companies located in large developed or emerging market countries. Different classes of bonds include corporate bonds, government bonds, international bonds, and even bonds that help protect against increases in inflation.

In other words, if there's a segment of the market you're interested in investing in, mutual funds likely have you covered.

Professional management

To replicate the diversification mutual funds offer, it would take a lot of time and effort to buy all the stocks or other securities held in one mutual fund. You might also feel like you need to respond to every twist and turn in the market even when you have years to go before you will need the money and might be better off just staying the course.

Mutual fund managers can do much of that work on your behalf. Because they buy and sell stocks and other securities in large blocks, their transaction costs are generally minimal. When it comes to picking investments, they're guided by disciplined rules, so they aren't subject to the same tug on emotions as individual investors sometimes experience.

How do you know if a specific mutual fund can be right for you?

When shopping for a specific mutual fund, it helps to decide first on which of the two types of mutual funds make the most sense for your situation. Index funds are generally lower in cost since they only seek to match the performance of the index they track and are comprised of the same investments held by existing market indexes, such as the Standard & Poor's 500® index of large U.S. companies. Actively managed mutual funds, on the other hand, offer the potential to outperform the market since the fund managers select the investments, including when to buy and sell them. Because they're more active, they tend to cost more than index mutual funds, and while they aim to outperform the market, they can also underperform. 

When comparing two like mutual funds, you might consider the following factors as tiebreakers:

Cost

Compare the funds' operating expense ratios—what the fund charges to cover its operating expenses. In addition, be sure to look for any loads—one-time sales commissions—or transaction fees the fund may have.

Performance

While historical performance is no guarantee of future results, look at the fund's track record of either matching the market's performance (in the case of index funds) or outperforming it (the goal of actively managed mutual funds).

Manager tenure

Fund managers who have managed investors' money through the ups and downs of full market cycles typically have better processes for maintaining their discipline during frothy and turbulent markets alike. This is especially important for actively managed funds.

Taxes

When a mutual fund sells investments that have increased in price, it will ultimately distribute the profit to investors in cash, which can impact the capital gains taxes you may owe. You can compare each fund's tax cost ratios to see how much its returns are reduced by taxes.

 

Deciding to purchase a mutual fund is a personal decision that depends on your individual circumstances. If you're unsure, be sure to ask a financial consultant for help.

Which mutual funds can help you achieve your goals?

Use these tools to find out.

Are mutual funds right for your portfolio?

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Investors should consider carefully information contained in the prospectus or, if available, the summary prospectus, including investment objectives, risks, charges, and expenses. You can request a prospectus by visiting Schwab.com or calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Diversification and asset allocation strategies do not ensure a profit and do not protect against losses in declining markets.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For more information on indexes please see www.schwab.com/indexdefinitions.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk, including loss of principal.

Performance may be affected by risks associated with non-diversification, including investments in specific countries or sectors. Additional risks may also include, but are not limited to, investments in foreign securities, especially emerging markets, real estate investment trusts (REITs), fixed income, small capitalization securities and commodities. Each individual investor should consider these risks carefully before investing in a particular security or strategy.

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