A big selling point of mutual funds is that they offer the benefit of diversification as opposed to buying individual securities such as stocks. If you invest in fixed-income securities such as a bond, you receive periodic interest payments. However, you can also invest in a bond mutual fund, which also gives you the benefit of diversification.
Mutual funds pool investors' money together to purchase securities. There are four broad categories of mutual funds: money market funds, fixed-income or bond funds, equity funds and hybrid funds. Investors pay the fund's expenses, including the salary of a professional money manager who oversees the securities that go into and out of the fund.
Mutual Fund Advantages and Disadvantages
There are several advantages to investing in mutual funds besides diversification. Mutual funds are liquid investments, meaning you can trade them as you do a stock. You also can participate in investments for a fraction of what it costs to own individual securities. While you enjoy these benefits, there are some disadvantages of mutual funds such as fees. You also don't have a say as to which securities are included or excluded from the fund, and you have less control over the timing of capital gains.
Fixed-income securities are debt instruments, meaning the investor receives periodic interest payments and a return of his principal from the borrower. Fixed-income securities come in a variety of forms, including corporate bonds, Treasury securities and municipal bonds. Bonds come in different denominations but typically sell for a face value of $1,000. In addition to bonds, preferred stock, which is a hybrid security, has the characteristics of a bond instrument, meaning the investor receives periodic payments. Fixed-income securities provide a steady source of income.
Fixed Income Advantages and Disadvantages
The main advantage of investing in a fixed-income security is that it provides a source of income: interest payments. In addition, income from municipal and state-issued bonds are exempt from federal taxes. And some with some fixed-income investments, such as certificates of deposit, you principal is protected from loss. big disadvantage of fixed-income securities is inflation risk. In other words, the fixed payments you receive do not increase if inflation occurs. There is also default risk, which is tied to the quality of the issuer. Although the U.S. government is highly unlikely to default, municipalities and corporations have defaulted on their bonds. Other risks surrounding fixed-income securities include interest rate risk, reinvestment risk and credit quality risk.
Bond funds and fixed-income funds are mutual funds that invest in fixed-income securities. You get the same benefits as mutual funds, such as diversification. In addition, you can have your interest payments reinvested in the fund. A disadvantage of bond funds is that a portfolio manager is constantly changing the positions in the fund, which changes the risk profile of the fund. In contrast, the risk profile of a bond declines the to closer it gets to maturity. One alternative to investing in a bond fund is to invest in a hybrid fund, which combines both stock and bonds as part of the portfolio.