Investing > What are Mutual Funds?

What are Mutual Funds?

Mutual funds have been the mainstay of the stock market for quite some time. What makes them so popular?

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Updated May 18, 2021

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Do you know where your money is?

Whether by your hand or not, you are probably already a shareholder of a mutual fund—or you will be at some point.

They are almost an unavoidable part of any retirement program and an appealing investment in their own right. They are easy to get into, offer instant diversification—increasing overall asset safety through that diversity—and have professional management.

Yet many people still don’t full understand how mutual funds work? ⚙️

How do they compare to other asset classes? Who are their biggest contenders, and why some investors—like many in China—aren’t all that in love with them? These might seem like unrelated questions for casual investors, but we would argue otherwise—knowing your mutual funds will have a big impact on the growth of your money over the long-term.

In this article, we’ll discuss what mutual funds are, how they make money, and how they make money for you. We’ll also look at various types of funds available, their competitors, as well as what each type is good and bad at—and we’ll see what can be done about those pesky taxes.

Ready? Let’s jump in! 🤓

What you’ll learn
  • Understanding Mutual Funds
  • How Mutual Funds Make Money
  • Types of Mutual Funds
  • Why Buy Mutual Funds
  • Limitations of Mutual Funds
  • Choosing Your Investment Strategy
  • How to Evaluate Mutual Funds
  • Buying Mutual Funds Online
  • Tax Implications
  • Mutual Fund Alternatives
  • Conclusion
  • Mutual Funds: FAQs

Understanding Mutual Funds ✅

While Mutual Funds began their life in the US in 1890, their history goes back even further. The first Investment fund, a harbinger of mutual funds, was created in the Dutch Republic in response to the financial crisis of 1772-1773. It was meant to help small investors diversify their portfolios—and Mutual Funds continue in that vein.

Mutual Funds are a bit peculiar as they are technically legal entities called investment companies. They specialize in trading various securities and splitting the profits with their investors—shareholders as they are called due to the nature of Mutual Funds.

The basic idea is that a typical investor has no easy way of diversifying their portfolio nearly enough on their own—which is necessary if you are seeking to optimize your assets under the modern portfolio theory—so a Mutual Fund does it in their stead by pooling resources from numerous small shareholders.

This means that you own stocks of a multitude of companies vicariously. By investing in a mutual fund, you provide the fund with the ability to purchase more securities—thus growing itself, and your investment with it, in value.

Mutual FUnds vs Stocks
Compared to individual stocks, mutual funds offer long-term benefits like diversification and tax benefits.

Mutual Funds are incredibly popular. They are relatively simple to use, they offer a good value proposition, and they offer professional management. Another reason they are so prevalent is the fact that most employer-sponsored retirement programs rely heavily on mutual funds—so much so that if you are under such a program, you are probably already a shareholder.

How Mutual Funds Make Money 💰

Mutual Funds have operational costs like any other business. The main way they cover these costs is through charging fees like the expense ratio. The expense ratio represents the sum of annual costs of running the fund and is expressed as a percentage of the assets under management.

Expense ratios on mutual funds vary but tend to stick between 1-3%—this means that if the expense ratio is 1%, the mutual fund will take 1% of your portfolio to pay themselves each year regardless of how high their yearly returns are. Note that mutual fund returns have hovered around 10% on average in the U.S. in the past decade.

In some cases, expense ratios can be significantly higher, or lower, going below 0.08%. It is good to note that overall, funds with lower expense ratios tend to give better results.

Some mutual funds also charge so-called load fees. These are not recurring expenses but rather something you pay when buying and selling the fund. Funds that don’t charge these fees are called no-load mutual funds.

Another type of commission is the 12b-1 fee. It represents the money paid for the advertisement of the fund. These fees are capped at 1% but it is still better to avoid them completely—1% might not appear like a lot, but it will eat into your returns significantly over time.

Mutual Fund Share Classes 🔎

Mutual fund share classes represent the number of fees being charged. There are seven of them, but the main ones are classes A, B, and C.

Class A shares charge a fee on your initial investment. This class is good for long-term investments, but it tends to come with a high buy-in price. Class-As offer discounts on 12b-1 fees, usually upon certain investment thresholds—for example, you get a discount if you invest $20,000 or more in the first two years.

Class B shares charge a fee when you sell your investment—and these fees tend to diminish after longer periods. This makes them good investments for the long term, but they are usually horribly expensive if your timeframe is short. Class B shares also tend to offer less voting power per share than class A shares. However, they also tend to convert to class A after being held for a few years.

Class C shares can be considered the best of the three for short-term investors as they only charge an annual fee. Still, they aren’t perfect as there is still a small selling fee if they are held for less than a year.

The introduction of the fiduciary rule back in 2017—the Department of Labour’s conflict-of-interest rule—gave a boost to the idea of clean shares. This rule demands that retirement advisors put their client’s best interest above their own.  It requires all fees and commissions to be disclosed to the client in dollar form—clean shares are the newest class and they do away with 12b-1s and various other fees.

Types of Mutual Funds 🗂

A big part of the reason why mutual funds are so popular is that they come in all shapes and sizes. They are usually distinguished either by the type of securities they are holding or by the way they make money.

The 10 main types of mutual funds,
What a mutual fund invests in varies vastly based on what type of fund it is.

As such, multiple mutual fund investments can act completely differently in various market conditions—one might do great during a boom, another during a recession, etc. However, note that borders between types aren’t impenetrable and there is quite a bit of overlap—a global fund can also be an equity fund for example.

Equity Funds ✔️

Equity funds are a very broad category that invests in—as the name implies—stocks. 

They are mainly differentiated by the size of companies they invest in, their investment strategies, and whether they target domestic, or foreign companies. 

When it comes to the size of companies, equity funds concern themselves with the market cap and the potential for growth. They might aim to be value funds that seek out underappreciated companies that perform well business-wise. Thus, their aim is to provide dividends to their shareholders.

On the other hand, an equity fund might target companies that have, or are expected to have a strong growth in earnings. These funds are called growth funds and usually have high price-to-earnings ratios.

Funds that invest in large companies can be viewed a bit like blue-chip stocks—safe investments that probably won’t grow like Mickey’s magic beans, but aren’t likely to tank either. On the other hand, there are equity funds that are focused specifically at smaller companies with market caps ranging from $300 million to $2 billion. These tend to be newer companies that haven’t proven themselves fully yet, but just might grow exponentially.

All of this makes equity funds friendly to most types of investors. If you want to play safe, go for the ones investing in big, safe companies. On the other hand, if you hope to catch a trend—one similar to Apple’s staggering and ever-continuing growth perhaps—you could always seek out funds that target smaller yet promising stocks.

Index Funds ✔️

Index funds follow the philosophy that you can’t outperform the market. They are passive funds that track a certain index—for example, S&P 500—and try to match it. They are great for investors that want to keep their costs down, as they carry fewer expenses—less research, oversight, and strategizing is needed than with an actively-managed fund.

A huge-yet-well-performing equity fund is Fidelity Contrafund Fund (FCNTX) that boasts a 10-year average of 15.60% and an even better 5-year average of 20.71%.

One major index fund is Schwab S&P 500 Index Fund (SWPPX) with an expense ratio of 0.02% and a 10-year average of 14.10%.

SWPPX just slightly outperforms the S&P 500
SWPPX just slightly outperforms the S&P 500. Image by TradingView.

Balanced Funds ✔️

Mutual funds are diverse by nature, and balanced funds take it even further. They are designed so that they contain various types of securities to minimize risk. The idea is simple: if you own stocks, currency, commodities, bonds, and other types of investments, chances of them all tanking simultaneously are minuscule.

This makes balanced funds great if you want to keep your savings safe but means that they are not likely to offer amazing returns. Diversification is a great buffer against a certain security dropping sharply and taking all your savings with it, but it also staggers gains of another—no matter how dramatic they are—if the rest of the fund stays at mostly stable prices. 

A subset of balanced funds follows a dynamic investment strategy—these are called dynamic funds. This means that they don’t have fixed allocations for various types of securities, but alter the percentages to meet different investors’ goals. 

This means that dynamic funds have a greater potential for earning money due to their agility, but it tends to somewhat sap their overall stability and security.

JPMorgan Investor Growth Fund Class A (ONGAX) is a balanced fund with net assets worth $4.11B, an expense ratio of 0.97%, and a 10-year average of 10.81%.

Fixed Income Funds ✔️

Fixed income funds aim for investments that offer a set rate of returns—various debt instruments generally. That means that a fixed-income fund will usually hold assets like corporate or government bonds. 

For example, Fidelity Inflation-Protected Bond Index Fund (FIPDX) is a fixed income fund with a 5-year average of 4.05% and an expense ratio of just 0.05%.

While they focus on providing steady income to their shareholders it is hard to tell exactly how safe these funds are. This is because there are many kinds of bonds and, for example, a fund that invests in high-yield junk bonds will be far riskier than one that invests in government or reputable corporate securities.

Generally, Warren Buffett warns against gambling on the market—and betting on the performance of junk bonds is certainly a risky gamble.

Income Funds ✔️

Income funds tend to invest in quality government and corporate debt. The main purpose of these funds is to provide regular income for shareholders by holding bond securities to their maturity. They are good for risk-sensitive investors—however, the fact that they provide regular returns means that they often incur a lot of income tax which is higher than long-term capital gains tax for stocks.

One Fidelity income fund is Fidelity Capital & Income Fund (FAGIX). Its expense ratio is 0.67%, and its 10-year average is 7.11%.

Money Market Funds ✔️

Money market funds invest in safe, short-term debt instruments—Treasury bills for example. They provide almost no returns but are mostly super-safe and a good place to park your money. Still, don’t expect them to really protect you against the effects of inflation—most of these funds can only slightly dull inflation’s tooth.

A rather pricey money market fund is Vanguard Treasury Money Market Fund — VUSXX with a minimal investment bar of $50,000 and an expense ratio of 0.09%. A more accessible option is Invesco Premier Portfolio Fund — IMRXX with a minimum of $1,000 and an expense ratio of 0.18%.

Global Funds ✔️

Global funds invest in companies from all around the world. They are hard to classify as their investment strategies and safety can vary greatly depending on different financial climates and legal circumstances of markets in various parts of the world. International funds can be considered a subset of global funds that only invest in foreign assets.

Both global and international funds are important vehicles for diversification. They help make your portfolio’s fate less dependent on the fortunes of a single market. For example, you can use them to make your bonds portfolio even less risky

Fidelity Global Credit Fund (FGBFX) is a global bond fund with $124.79 million net assets, an expense ratio of 0.75%, and a 5-year average of 4.29%. DSP World Agriculture Fund – Direct Plan – Growth (0P0000XW34.BO) is another global fund with an expense ratio of 1.14%, and a 5-year average of 8.34%.

Regional Funds ✔️

Regional funds—as the name implies—focus their investments in one region or country. They are great for getting exposed to otherwise hard-to-reach markets. They are also hard to label as safe or risky but it is better to err on the side of caution and consider them potential high-reward and high-risk investments.

Fidelity Nordic Fund (FNORX) is a regional fund that invests in Scandinavian securities. It has a 10-year average of 10.11% and an expense ratio of 0.96%. It is also a nearly three-decade-old fund which makes it somewhat easier to figure out what to expect from it based on its performance records.

Dividend Funds ✔️

Dividend funds target companies that pay dividends to their investors. Dividends represent a portion of the earnings paid to investors—often quarterly—as a reward and incitement to keep investing. You can choose whether you want to collect the money from dividends, or reinvest it—perhaps by setting up a sustained dividend reinvesting plan (DRIP).

You should be mindful though that dividend income is taxed as regular income so it is probably best to invest into these funds through a good IRA or Roth IRA. It is also important to note that even the reinvested dividend income has to be reported to the IRS or else fire will rain from the sky (or whatever the IRS does when someone is late with a tax payment).

Vanguard High Dividend Yield Index Fund Investor Shares (VHDYX) has a yield—income returned to the investors through dividends and interest—of 3.05% and a 10-year average of 12.95%. Its expense ratio is 0.14%.

Socially Responsible Funds ✔️

These funds are built with the ethical investor in mind. They try to be competitive while avoiding investments in companies that don’t meet certain moral criteria. For example, they may avoid investing in companies that trade and manufacture weapons or tobacco, major polluters, or even certain famous chocolate-makers implicated in modern-day slavery.

Right now, green energy is a very dynamic market, which makes it a prime target for socially-responsible funds. One such fund is Firsthand Alternative Energy Fund (ALTEX) which boasts a 10-year average of 5.94%, and a 5-year average of 20.79%.

Apart from your moral compass, you should consider the practicalities of these funds. Which ones to avoid or aim for will depend on their portfolios as well as your personal investment goals.

Another example of a socially responsible fund is 1919 Socially Responsive Balanced Fund Class A (SSIAX) with an expense ratio of 1.26%, net assets of 667.17 million, and a 5-year average of 13,70%.

Fund TypeFund NameExpense Ratio (%)5-Year Average (%)Assets ($)
EquityFidelity Contrafund Fund (FCNTX)0.8620.71138.35B
IndexSchwab S&P 500 Index Fund (SWPPX)0.0216.2555.79B
BalancedJPMorgan Investor Growth Fund Class A (ONGAX)0.9713.733.89B
Fixed IncomeFidelity Inflation-Protected Bond Index Fund (FIPDX)0.053.539.43B
IncomeFidelity Capital & Income Fund (FAGIX)0.677.2113.61B
GlobalDSP World Agriculture Fund - Direct Plan - Growth (0P0000XW34.BO)1.148.34
RegionalFidelity Nordic Fund (FNORX)0.9613.15393.44M
DividendVanguard High Dividend Yield Index Fund Investor Shares (VHDYX)0.148.9335.61B
Socially Responsible1919 Socially Responsive Balanced Fund Class A (SSIAX)1.2613.70667.17M

Why Buy Mutual Funds 💭

Without a doubt, one of the biggest advantages of mutual funds is professional management. This means that your money will be handled by people with experience and know-how that should make the best possible decisions.

But this can come at a price—literally. Mutual funds also tend to boast numerous expenses and fees which might sometimes make them not worth it, at least not when compared to some other asster types.

Another major advantage of these funds is the security in the diversification they offer. As we discussed before since mutual funds invest in a wide variety of assets, you shouldn’t feel shifts in the value of individual stocks too much.

Mutual funds also come with great liquidity. This is mostly because they are always redeemable. This means that you can sell your shares back to the fund for cash at any time—well, almost any time.

Limitations of Mutual Funds ⚠️

Mutual funds are traded only at the closing of the market. This has the benefit of fewer individual trades being made throughout the day—driving transaction fees down—however, it also means it is hard to catch lightning in a bottle and buy or sell at the perfect moment. Knowing when to sell your stocks isn’t worth much if you can’t actually sell them at the right time.

This might not seem like much, and probably isn’t in most cases, but good outcomes are usually achieved with small-yet-constant victories. Fractions of a percent in trade can compound into major gains or losses in the long run.

This liquidity of mutual funds also makes them less investment-efficient—they always have to hold a significant cash reserve to be truly redeemable—thus they can’t go all-in on investing. On the other hand, their guaranteed liquidity is a major asset in its own right.

In a way, the end-of-day trading of mutual funds can also be seen as an advantage. It limits management abuses that are certainly possible with mutual funds. These abuses include excessive trading, selling assets early to fix the books—significantly reducing tax efficiency—and other such dishonorable tactics.

Last but not least, the ease of access mutual funds offer is another great advantage. It makes it a lot easier to invest in a wide array of securities, even the rare and exotic ones, at fair prices. This is compounded by the mostly low buy-in prices that go as low as a few hundred bucks but often hover around $2500.

The Good and the Bad with Mutual Funds

Pros

  • Safety through diversification
  • Professional management
  • Ease of access
  • Guaranteed liquidity

Cons

  • High expenses
  • Tax inefficiency
  • Possible management abuses
  • Limited trading time

Picking a Mutual Fund Investing Strategy ⛏️

To decide on a strategy you need to set your goals. These could overall be divided into the aggressive, cautious, and mixed tactic. So, let us see how each of these might look.

A Single Aggressive Strategy 🚀

An aggressive strategy would have to entail vigorous research—it promises the highest potential payday, but these promises can be treacherous. You would ideally seek out an actively-managed fund that invests in companies that are likely to grow significantly.

Another possible target could be a fund that specializes in high-yield junk bonds. However, you should also be very careful. Don’t let yourself be fooled by a mutual fund’s high year-to-date (YTD), or one-year average. You ideally want a fund with a long track record: five, or even better, ten-year averages are what you should primarily look at.

You should also try and identify any changes in the management of the fund. A well-performing risky fund might get new and unproven overseers—lessening the value of its track record. Of course, the opposite might happen as well. A lackluster fund might suddenly find itself in the hands of a proven market wizard.

Lastly, such a dynamic fund could and would probably have high fees. If you are very confident in its performance, it might be worth it to pay a significant chunk of your earnings to the fund—but this kind of strategy is very risky from the get-go, and if it fails, the last thing you’d want is exorbitant fees kicking you while you are down.

Keeping it Steady 🚂

Another strategy you could employ is seeking out safe funds and aiming for passive management. This could entail investing in an index fund. This way, you could just park your money and check the stock market every once in a while—if you see that the index your fund is tracking is up, your investment should also be up.

This can generally be regarded as a safe option as the stock market has been doing great over the past years. Additionally, as we are emerging from the covid-19 crisis thanks to mass vaccinations, even the age-old adage of sell in May is going out of the window.

One more benefit of this approach is lowered costs. Since a passive fund requires less oversight, the management fees tend to be almost negligible compared to active funds. You could even go all-in on the hands-off approach and get a robo-advisor for your portfolio.

Keep in mind that a passive strategy like this can really provide good returns over long periods. The low management costs ensure that you keep most of what you earn, and the generally steady nature of indexes like the S&P 500 means that you are not likely to experience any significant losses over the lifetime of your portfolio.

Master of Both Worlds ⚖️

A balanced fund could be a great ally if you are going for a middle-of-the-road option. A dynamic, balanced fund could be set up so that it invests in newer companies with a better chance for growth early in your investing career, but gradually move toward safer securities as you approach retirement.

This can really be a great strategy as it combines the potential for a high payday of an aggressive approach with all the benefits of diversification that mutual funds offer. However, note that such a dynamic fund would likely be actively managed.

This—along with the risk of the initial aggressive phase—could ultimately lose you money if you aren’t careful. Basically, as with the previous two strategies, you should do careful research before investing—your long-term prosperity is on the line.

How to Evaluate Mutual Funds 👨‍🏫

Figuring out your risk tolerance and overall goals is all fine and dandy, but how in the world do you pick the right fund for you? Well, there are a few concrete and actionable steps you can take to make sure you can put your money where your mouth is.

1. The Track Record 🕰

While the past is an unreliable augur of the future it’s still worth a look. Before picking a mutual fund you should peer into its records—ideally its 10-year average. Even this measure can be deceptive, but generally, a fund that has had stable returns over a decade is likely to continue strong.

This measurement is important even if you are looking for short-term investments. Even a fund that had more than a 100% in returns in, say, 2017 isn’t worth much if it consistently loses money over its lifetime—there is no guarantee that the year you pick to invest will be good.

2. Keeping Ahead of the Peers 📚

So, you found a fund that has a good track record and specializes in what you are interested in? Great. But how does it compare to other similar mutual funds?

You should always check other similar funds before making the final pick. This is rather self-explanatory but no matter how seemingly good or bad a fund is it might not be the best choice if others consistently outperform it.

This holds even if it looks really bad. A fund with very low returns might still be the best in its class. This should indicate to you either that a change in strategy is in order, or that you should adjust your expectations going in.

Also, consider the pricing. A really profitable fund just might have significantly higher operational costs than its peers—ultimately eating into your earnings and getting you less money than a cheaper more conservative mutual fund would.

3. Management 👨‍👩‍👧‍👧

The fund manager is a very important person. You should try and check their personal track record as well as their track record with the fund. 

A poor-performing fund might even bring in a hot-shot manager to set it on an upward trajectory. However, that excellent manager might have made their name trading crypto and has little experience trading the assets your fund is managing, so make sure to look at more than just the amount of money their managerial skills have made.

If you are very tax-conscious, an aggressive manager that makes lots of profitable sales might not be right for you—aggressive trading can lead to taxes piling up.

4. Size Can Kill 🚨

Since mutual funds are guaranteed redeemable, liquidity shouldn’t be an issue. This means that, unlike ETFs, their trading volume and assets under management aren’t that big of a concern. That being said, there is only so much a person or a team can do, and a fund can simply become unmanageably large.

For example, this happened to Fidelity’s Magellan Fund back in 1999. It topped a staggering $100 billion which caused it to change its investment process—adversely affecting performance.

How big is too big—or how small is too small—has to be evaluated on a case-by-case basis, but if you aren’t entirely certain what you are doing, funds over $100 billion should generally be avoided.

Small funds are usually not an issue as they should have set their goal accordingly—meaning they should accomplish it without issue. Still, checking its track record and comparing it to peers is a good way to be sure you aren’t making a mistake.

How to Buy Mutual Funds Online 👨‍💻

Buying a mutual fund online is as simple as owning a smartphone, computer, or tablet. There are three main investment avenues: directly buying from the fund’s owner, buying from a funds owner that also offers third-party funds, or investing through a broker.

Buying from the fund owner is good as there are no brokerage fees or sales commissions. The drawback is that you can only choose from a handful of funds owned by these companies.

Famous companies like Vanguard and Fidelity offer a hybrid solution—they offer their own as well as competitors’ funds. The catch is that you are offered better deals on internal funds—Vanguard prefers Vanguard mutual funds and so on. 

Basically, you are discouraged from buying outside funds by additional fees.

Buying through a stock broker offers the widest range of funds—nearly all of the funds available on the market. The drawback is that many brokers charge commissions on every trade, and the fees, in general, are more plentiful. Still, brokers are not in short supply, and it is never too hard to find the right ones for your budget—especially since the top discount brokers offer commission-free investing for most asset types.

Here a few examples of brokers known for their access to mutual funds:

Fees
Minimum initial deposit

$0

$0

Commissions

Vary

$0

Account minimum

$0

$500

General
Highlight

Huge discounts for high-volume trading

Low fees

Best for

Active traders

Beginners and mutual fund investors

Promotion
Rating
Fees
Minimum initial deposit

$0

TS Select: $2,000

TS GO: $0

Commissions

$0

$0

Account minimum

$500

$0

General
Highlight

Low fees

Powerful tools for professionals

Best for

Beginners and mutual fund investors

Active options and penny stock trading

Promotion
Rating
Fees

Minimum initial deposit

$0

$0

TS Select: $2,000

TS GO: $0

Commissions

Vary

$0

$0

Account minimum

$0

$500

$0

General

Highlight

Huge discounts for high-volume trading

Low fees

Powerful tools for professionals

Best for

Active traders

Beginners and mutual fund investors

Active options and penny stock trading

Promotion

Whichever you choose you’ll have to open an associated account. While opening a brokerage account isn’t always well understood, it is pretty straightforward—the same goes for signing up with firms like Fidelity. You’ll need to select what type of account you want, provide personal info, and other such common things.

All this is slightly different if you are investing through an employer-sponsored plan. The gist of it is the same. However, the amount of control you have will be different depending on the exact plan, and your options will be limited to a selection of offered mutual funds.

Tax Implications of Selling Mutual Funds 💸

Mutual funds are somewhat hampered by their tax inefficiency. Every time a fund manager sells a security a capital gains tax is triggered. This is particularly bad if that security has been held for less than a year, as short-term capital gains tax is pretty punishing.

One way of mitigating this issue is through tax-loss harvesting. This is a practice where you intentionally sell some assets at a loss in order to mitigate taxes on your yearly gains.

A far simpler solution would be using a tax-privileged account. These include 401(k)—employer-sponsored retirement plans—IRAs, and Roth IRAs. This means that you can avoid the hassle of paying taxes until you withdraw your money—or even altogether.

You can do this yourself, but it is generally advisable to find a good broker for your Roth IRA, or IRA to help you out along the way—no matter what you are doing, or how clever you are, a professional will likely do a better job.

If you find tax-loss harvesting too much of a risk and hassle, and can’t or won’t open an IRA, there are tax-sensitive mutual funds. However, these are likely to be better for parking than for making money.

Mutual Funds as an Asset Class 👇

The biggest benefit mutual funds offer is instant diversification. This fact alone has given them a lot of staying power and has made them as popular as they are. Apart from this, it is hard to really give an umbrella analysis of mutual funds—they deal with various types of securities and each has its quirks.

Types of Investments
Mutual funds are just one of many security types you can invest in via a broker.

A big contender for the throne held by mutual funds are exchange-traded funds. ETFs, as they’re usually called, offer the same level of diversification while having lower costs.

Still, the fact that mutual funds are here to stay is highlighted by the performance of funds like AQR Large Cap Defensive Style Fund (AUEIX) which boasts a 5-year average of nearly 14%.

This is possible because it tries to emulate a study called Buffett’s Alpha. This study has delved deep in its attempt to unravel the secrets of Warren Buffett’s success—and has so far proven promising.

Innovations like this will likely help mutual funds remain the big player that they are. However, it also paves the way for further automation on the stock market. Effects this will have are hard to predict, but big winners are sure to be mutual funds, ETFs, and robo-advisors whose future is likely already bright, if a bit unclear.

Mutual Fund Alternatives 🗃

As we’ve already mentioned, mutual funds’ biggest rivals are probably ETFs, however, other asset classes—like blue-chip stocks and cryptocurrencies are worth a gander as well. Let’s see what the main contenders are.

Mutual Funds vs. ETFs ⚖️

We live in interesting if a bit depressing times, we really do—but we don’t quite witness history being made every day—and Guinness Atkins Funds did just that. They announced in late March of 2021 that they converted two mutual funds into ETFs.

This highlights the rivalry between these two types of funds. Mutual funds are still strong, but exchange-traded funds are seriously catching up. This is because ETFs have two crucial advantages:

They are traded throughout the day, and they usually boast lower expense ratios.

These advantages are compounded by the fact that ETFs might just be even easier to access than mutual funds—the buy-in price can be as low as the cost of a single share, or even lower if the broker is willing to allow buying a fraction of a share—and can offer an even more hands-off experience. Furthermore, they can be downright inspiring for people who wouldn’t otherwise consider investing to try it.

So, let’s see how one of the biggest ETFs compares to the aforementioned AUEIX mutual fund.

DescriptionAQR Large Cap Defensive Style Fund Class I (AUEIX)Vanguard Total Stock Market Index ETF (VTI)
Assets$5.8B$1.15T
Yield1.25%1.37%
Expense ratio0.40%0.03%
5-year average13.83%16.69%

While the difference in assets between these funds might appear staggering, remember that, unlike ETFs, net assets and trading volume of mutual funds aren’t that important for investors liquidity-wise—a huge total value can even hamper the performance of mutual funds.

Mutual Funds vs. Blue-Chip Stocks ⚖️

Blue-chip stocks are considered a safe and stable investment. Hence, they are excellent long-term investments. 

However, mutual funds are so popular with retirement plans for a good reason—they offer diversification, which would take painstaking planning if one was to buy stock individually—and while blue-chip stocks are generally a safe bet, it is better not to put all your eggs in a single basket.

So, if you are not only looking to keep your savings safe but earn serious money, mutual funds are probably a better choice. You could always invest in a fund that holds blue-chip stocks as an extra layer of security.

That being said, you can still earn money from blue-chip stocks through dividends. On the other hand, mutual funds can offer the same advantage alongside the opportunity for growth investing.

Mutual Funds vs. Cryptocurrencies ⚖️

This might appear like a strange comparison—mutual funds are considered a generally safe long-term investment while cryptocurrencies can be… volatile to say the least—but they do have a certain overlap.

On one hand, there are mutual funds that aim for aggressive growth investing, not too dissimilar to trying to get in on the next Bitcoin boom. On the other, crypto is considered a bit like a failsafe in case of a crisis—its decentralized and independent nature means it is often viewed as an alternative to investing in gold during dangerous times.

This comparison is likely to gain relevance as there is a strong push to get BTC ETFs approved in the US. The main choice you have to make here is whether you want to take a big risk and maybe quickly become a billionaire—no mutual fund can boast a price of less than $1 ten years ago and around $60,000 in 2021—or play it safe and still likely get very decent returns by the time you retire.

Conclusion 🏁

Mutual funds have come a long way over their century-long history and it takes a long time to get to know them properly—something undeniably important considering how prevalent they are. Their sheer staying power makes them reliable and somewhat easy to track over time, and the diversification they offer has made them such a default choice for so long.

Still, recent years have brought a worthy contender in the form of ETFs, and mutual funds’ supremacy is no longer guaranteed. Their continued existence almost certainly is though and many of the advantages they have always offered still make them at home in any portfolio. Additionally, their inception as a means to help the small investor out makes them somewhat noble, and something we can’t help but root for.

Mutual Funds: FAQs

  • When are Mutual Funds Traded and When Do They Update?

    Mutual funds are traded after the markets close at 4 p.m. E.T. and their updated values tend to be posted by 6 p.m. E.T. This sets them apart from ETFs and stocks which are traded throughout the day.

  • How Many Mutual Funds Exist?

    There were approximately 123,000 mutual funds worldwide in 2019. In the same year, there were 7,945 mutual funds in the US.

  • What is the Average Yearly Return on Mutual Funds?

    The mean 10-year average for mutual funds is 7.16%. US large-cap stock funds boast the highest 10-year average of 12.02%, and short-term bond funds hold the lowest at 1.91%

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