Stacks of quarters increasing in height to represent the five reasons you shouldn't invest in mutual funds.

5 Reasons You Shouldn't Invest in Mutual Funds

Mutual funds have long been a staple of investing. They provide access to many different types of investments with a relatively low level of risk, but there are downsides as well. Here are five reasons you should not invest in mutual funds.

  1. Over-Diversification Can Stifle Returns

    Some people are drawn to mutual funds because they contain a diverse array of investments. This diversification of the holdings is meant to protect investors in case a few investments fail. Unfortunately, it can also stifle returns for investors. Over-diversification means the mutual fund holds so many different investments that it is difficult to perform better than the markets. Over-diversification can also minimize growth as gains are cancelled out by losses. This can keep your returns low.

  2. Lack of Control

    If you invest in mutual funds, then you essentially have no control over what is happening with the investments. All of the decision-making is done by the fund manager or a board of manager who could make poor decisions. If this happens, the only option is to sell out of the fund. This lack of control can leave investors feeling helpless, especially when a mutual fund starts to lose money or perform poorly.

  3. Fees

    Mutual funds can come with heavy fees. All investors need to pay the expense ratio each quarter or each year. This is the fee required for simply owning part of the fund. Expense ratios are the percentage of the total assets used exclusively for operating costs, like manager salary, marketing costs, and other fees. You must also pay fees and commissions for making transactions with a mutual fund. This is called the sales load or sales charge. These fees can significantly reduce returns from a mutual fund over the course of a decade or two.

  4. No Protections against Losses

    Mutual funds have no protection against losses. If you invest in a mutual fund, then everything that you put into the fund could be lost completely. The principal, the initial amount that you invest in a mutual fund, will not be returned. Some types of investments have mechanisms or guarantees that can protect the principal so that it is always returned to the investor. You should seriously consider what you could lose, especially if the money you want to invest is intended for retirement.

  5. Many Underperforming and Poorly Managed Funds

    Mutual funds have gained in popularity over the years. There are now thousands of different mutual funds available. This abundance is actually a bad thing because it makes it difficult to tell which funds are legitimate. Nearly three-quarters of all mutual funds underperform the stock market or lose money on a regular basis. If you do not have a strong financial background, then selecting a mutual fund can be hard.

Last Updated: June 24, 2015