Why Are Mutual Funds Such A Popular Investment Vehicle?

Did you know that there are more mutual funds than there are stocks? Have you ever wondered why mutual funds are such popular investment vehicles? Conventional wisdom will tell you that mutual funds are popular because they are less expensive than stocks because they do not carry hefty commissions, they allow the little guy to invest in the markets because the start-up capital can be small, they offer diversification because they hold many investment positions, and finally, they are managed by professional money managers. Unfortunately, these are the reasons given to investors, but the truth is that mutual funds are popular because mutual funds are extremely profitable to the investment industry.

Mutual funds may seem inexpensive because the costs are hidden. Mutual funds are loaded with fees such as sales charges, management fees, and 12b-1 fees. Sales charges are front-end loads charged by the broker or advisor for buying mutual fund shares, and charges for selling mutual funds shares are back-end loads. These charges depend on the various classes of shares. For example, Class A shares usually have front-end loads and Class B shares usually have back-end loads. Front-end charges can be as high as 8.5 percent for Class A shares. This means that an investor with $10,000 is only putting $9,150 to work while $850 goes toward the sales charge. In addition to sales charges, someone has to manage the fund and therefore, also has to be paid a management fee. This fee can range from 0.10 to 2.00 percent per year and depends on the fund itself and its investment style. Another type of fee is 12b-1 which is paid to brokers or advisors to pay for marketing, distribution and service costs. The Financial Industry Regulation Authority (FINRA) allows funds to charge 12b-1 fees as high as 1.00 percent on an annual basis.

Adding up all of the fees, it is no wonder that mutual funds are popular on Wall Street. It’s a great business because everyone except the investor benefits from this investment vehicle. Unfortunately, for the investor, the returns are not as good as the investment industry promises. The average investor in a stock-oriented mutual fund generated 5.66 percent per year over the ten-year period ended December, 31, 2007, according to a study by Dalbar, Inc., a leading financial services market research firm. Notice that this doesn’t include the stock market decline in 2008.

But are all mutual funds bad? No, not all mutual funds are created equal. Saying that all mutual funds are the same would be equivalent to saying that all restaurants are the same. Mutual funds are simply investment companies that make investments on behalf of their investors. There are some mutual funds that delivered fabulous investment performances for its investors and did not charge outrageous fees. But the problem is that most of the investment public would never know about them because these funds don’t advertise much, and they don’t pay high commission fees to entice brokers and advisors to sell them. In other words, they don’t play the Wall Street game.

About the author

Mariusz Skonieczny is the founder and president of Classic Value Investors, LLC, an investment management company. He is also the author of Why Are We So Clueless about the Stock Market? Learn how to invest your money, how to pick stocks, and how to make money in the stock market.

Filed Under: financial education

  • Great info. The public is clueless on the hidden costs of mutual funds.
    .-= DIY Investor´s last blog ..Investment Musings =-.

  • This is a very informative article. Thanks for sharing about mutual fund, I really need this info. Keep on sharing.

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  • Great post.

  • There are few reasons why mutual funds are popular. One of them – funds are simple to invest. But the main reason is marketing…

  • I used to think they are great as they are easy for anyone but since I lost so much savings, I'm not sure anymore.

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  • I think because it is easy because you have someone else to watch it

  • asdas

  • For twenty years, I invested all my savings every month in mutual funds.  Now I have hardly anything to show for all my hard work.  Guess only the fund managers got money.  Since last year, I did my own investment and I'm seeing good results.

  • Fees can ruin your portfolio returns, not only in mutual funds but in all investments.  I prefer mutual funds because between being a mom, a wife and a business owner I don't have time to manage a stock portfolio.  However, one of my top requirements is analyzing the fees and the returns to make sure it is worth it.  Index funds and EFT are a great alternative if you can't find funds that are reasonably priced and actually making money.

  • CQF

    I’m new in mutual funds and things are going well so far. I prefer MF as I don’t have the right expertise in managing stocks. You’ve stated a good point here.

    CQF @ CME Capital Australia