When two or more investors combine their funds together in an investment account, they create a "pooled fund." Groups such as investment clubs, partnerships and trusts use pooled funds to maximize their resources for investing in different vehicles. "Mutual funds" represents one type of investment vehicle that's driven by "pooled funds." Other pooled-fund investments include stock funds and bond funds.
A pooled account treats a group of investors as a single account holder, which allows them to buy more shares and further diversify their portfolios.
Pooled Funds and Investment Opportunities
The primary advantage of pooled funds is that they enable group members to take advantage of opportunities available only to large investors. These opportunities include economies of scale and economies of scope. Economies of scale allow group members in pooled funds to purchase investments that would not be available to smaller investors.
Economies of scope allow group members to save on transaction costs. The transaction cost for one purchase of 10,000 shares is often much smaller than those on ten purchases of 1,000 shares each.
Individual Investors and Autonomy
A major drawback of pooled funds is that the individual investor has less power over the group's investment decisions. Each member of the group will have varying goals, risk levels and exit strategies for their investments.
The investment group much reach a consensus before making critical decisions and the decision made by the group may not necessarily reflect the best interests on an individual investor. In a volatile market, the time and effort spent to gather that consensus can take away from the opportunities to gain quick profits or reduce potential losses.
Direct Decisions and Mutual Funds
Mutual funds also pool money from a members of the public and use that money to buy stocks and bonds. A vital advantage that mutual funds have over pooled funds is that they allow for the individual investor to make direct decisions.
Although a fund manager handles the day-to-day tasks of which stocks will be included in the mutual fund portfolio, the individual investor can make decisions on which funds to buy and sell as the market moves. Mutual funds are also regulated by the US Securities and Exchange Commission, which protects investors from fraud and incompetence.
Exploring Drawbacks of Mutual Funds
Two notable drawbacks of investing in mutual funds are the lack of investor control and the transaction fees. The investor has no power to dictate which stocks will be in a mutual fund portfolio. The fund manager decides which stocks will be included and what goals the fund hopes to accomplish.
When an individual investor wishes to sell shares of one mutual fund to buy another, each transaction carries an additional fee. These fees can wipe out any potential gains from changing funds.
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