Why do financial advisors like to recommend/include mutual funds in clients' portfolios?
Question:
Answer:
you've heard the expression, "don't put all your eggs in one basket"
mutual funds contain many stocks fitting the profile of the fund. This spreads the risk between many companies. At the same time, you want to have several different types of funds that have a diversity of profiles. This add a greater level of reward for the same risk.
The idea is that different companies behave differntly under different conditions so a well diversifed portfolio will capture the overall market, but smooth out the extremes. Also it is easy to adjust to capture long term trends.
This process is called 'asset allocation' and it is the strategy that returns the highest returns
most people don't do the research necessary to choose stocks. they look at what's popular, what others say, what they hear on TV.
go out to the internet and get real familiar with these terms:
Asset allocation
Long term investing
inflation
Roth ira vs ira
Large med small cap
Value vs growth
Indexed mutual funds
ETF
Sector funds
Bonds CD
International funds
Market cycles
Fundamental analysis
Technical analysis
Good Luck
If there is one thing we know from Modern Portfolio Theory it is that we ought to have well diversified portfolios. Well diversified portfolios allow us to get a decent return on our investment, but also get rid of a lot of the company specific risks.
It is difficult for an investor to have a well diversified portfolio unless he holds at least 30 different stocks. This means that people without a lot of money are at a disadvantage. They have to take on risks that they are not rewarded for taking on. However, if they buy a mutual fund instead of individual stocks, they are able to invest in a well diversified portfolio.
For two reasons; first, because mutual funds usually hold a number of individual stocks, they provide instant diversification, which is important to stable returns, especially for beginning investors. Second, many funds have a substantial sales load (up to 5% of the money you invest) which gets paid to the broker for selling you the fund. You should tell you broker you only buy no-load funds, and preferably exchange traded funds. There are several web sites which analyze the loads, charges, and expenses of mutual funds. Google 'mutual funds', or try Morningstar.com
Financial advisors like to recommend/include mutual funds in clients' portfolios because it is an easy way for a client to become instantly diversified.
Mutual funds represent diversification. ETFs offer advantages over mutual funds and I think any good financial advisor should put you in ETFs over mutual funds unless they stand to gain more financially themselves by placing you in a mutual fund.
Typically FA's like to recommend Mutual Funds for two specific reasons:
I. As a vehicle they may provide some diversification.
II. They often receive direct compensation for selling
mutual funds
In addition, FA's are generally not available to either do stock selection, or porfolio management, as the main difficulty is to gather enuf clients and enuf money under their hats to maintain a satisifactory income.
While the deck is not stacked against clients working with FA's, managing these dynamics can be tricky.
Some like to manage their own,thru online brokerage accounts, and online insurance purchases, etc.
Its a big world and room for everyone under the sun.
Good Luck
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