In the era of zero-commission trading apps, meme stocks and cryptocurrency, mutual funds seem old-fashioned to some investors. After all, mutual funds were introduced to the investment world way back in 1924, and you can only buy or sell a mutual fund once per day. But some of the things that make mutual funds seem “old-fashioned” can actually work to the benefit of investors. If you’re the type of investor who has previously overlooked mutual funds — or even if you already own them and are wondering about their value — here’s a look at the ways that a mutual fund can be your best financial friend.
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They Encourage Auto-Investment
In many ways, mutual funds are the best possible option for long-term investors, as they encourage behaviors that tend to improve investment results. Contributing to an investment account on a regular basis is one of the best ways to build up a long-term nest egg, and mutual funds purposely make this easy. When you buy a mutual fund, you can link it to your bank account and sign up for automated transfers on a regular basis, be it quarterly, monthly or even weekly.
An automated investment program helps make long-term investment success more likely for a number of reasons. First, it removes emotion from the equation. It’s human nature to plow more money into the stock market when it is red-hot and to take it out during bear markets, and that’s the exact opposite of what you want to do as an investor. With automated investing, you’ll constantly be contributing to your mutual fund regardless of the current market condition. Essentially, you’ll be buying fewer shares when the market is high and more when it is low, which can improve your long-term investment results. It also prevents you from overlooking a regular contribution to your investments, which can easily happen if you simply get busy.
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They Discourage Frequent Trading
The rise of zero-commission investment apps has no doubt increased participation in the stock market among a new wave of investors. While increased accessibility to the market is generally a good thing, it’s a bit of a double-edged sword. Although no one likes to pay fees to trade stocks, they do have the ancillary effect of slowing down trading. People are inherently likely to trade more often if they don’t have to pay for the privilege, and this can lead to overtrading. The rise of so-called “meme stocks” like GameStop and AMC Entertainment — which can rise and fall by hundreds of percent in just a matter of days — is the perfect example of this. While rapid trading can be exhilarating, it’s rarely a successful long-term investment strategy.
The very structure of traditional mutual funds prevents the potential of overtrading since they can only be bought or sold once per day. In reality, most mutual fund holders keep their investments for years, not days. As research has shown that the vast majority of day traders actually lose money, it only makes sense to pick solid investments and keep them for the long run, adding when they fall in value. A good mutual fund can help protect you from yourself, especially if you have the tendency to overtrade when left to your own devices.
They Reduce Risk
One of the many advantages of a mutual fund is that it allows you to own a diversified portfolio with a single investment. Although all mutual funds are different, most offer diversified portfolios holding 100s of individual stocks, all managed by professional investors. This is particularly important if you are a smaller investor with only a couple of hundred or thousands of dollars to invest. Rather than buying just one or two different stocks with that money, you can instead own a portion of 100 or more different companies by buying a mutual fund. A diversified portfolio will smooth out the ups and downs of all of the individual stocks it contains, reducing risk and making it much easier to sleep at night. While it may be exciting to own a stock that can trade up by 10% or more in a single day — something a mutual fund is highly unlikely to do — it’s also nerve-wracking when your individual stock trades down by 20% or more. Putting all of your investment money into a single stock that turns out to be a loser can be absolutely devastating to a long-term financial plan. Mutual funds avoid this risk by offering diversified portfolios that can give you both peace of mind and successful long-term financial results.
The Bottom Line
No single investment is appropriate for everyone. What’s best for you will depend on your investment objectives and risk tolerance, preferably developed in conjunction with a financial advisor. But there are many structural aspects of mutual funds that can make them great long-term investments for some investors, especially in an age where speculation and overtrading run rampant.
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This article originally appeared on GOBankingRates.com: 3 Ways Your Mutual Fund Can Be Your Best Financial Friend
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