Mutual Funds - Tic-Tac-Toe & Beyond

There are different types of funds, a good and necessary step is to identify its Morningstar style box. The Morningstar style box looks like a tic-tac-toe board. It is a nine-square grid that gives you a quick and clear picture of a fund's investment style. The style box classifies funds by whether they own large-, mid-, or small-capitalization stocks, and by whether those stocks have growth or value characteristics or land somewhere in between.

Selecting a particular fund style can enable investors to have an important degree of risk control. For example Large cap value funds have assumed about 50 percent less volatility compared to average fund where as small growth fund have assumed about 50 percent more. Taking the analysis a step further - risk-adjusted returns almost doubles when we move from small growth fund to large value fund in the category and style. In fact investors who rely on style specific funds can then reflect personal risk preferences. Let’s look at them one by one.

Index funds Revisited

Index funds are about as simple as it gets. They simply own the index. They are passive investors – yep dull and boring. Index funds have plenty of benefits. Most important, they tend to be low in cost. For example, Schwab 500 Index's SWPPX expense ratio is just 0.09% versus 0.84% for the typical large-blend fund. Because the index-fund managers aren't actively managing their funds—instead of making buy and sell decisions, they're simply doing what the index does—management fees tend to be low.

Index funds are also advantageous because they are fairly predictable. First, they tend to return what the index does, minus their expenses. Second, they always own what the index owns, which means they tend to be style specific. For example, if a fund indexes the S&P 500, that means it owns large-blend stocks; it'll own those types of stocks today, tomorrow, and the next day.

Growth Funds

The majority of growth managers are earnings-driven, which means they use a company's earnings as their yardstick for growth. Some managers look for earnings surprise, some look for firms which can generate long term capital appreciation and some just hunt for steady growers. Managers who seek growth at a reasonable price (GARP) try to strike a balance between strong earnings and good value. . As a result, these funds can land in the blend column of the Morningstar Style Box.  The hope is that these rapidly growing companies will continue to increase in value, thereby allowing the fund to reap the benefits of large capital gains.

In this style there are three categories depending on the fund’s average market capitalization – large, midcap and small cap funds. In general, growth funds are more volatile than other types of funds -- in bull markets they tend to rise more than other funds but in bear markets they can fall much lower, but there are mamagers who have delivered otherwise. Small cap growth funds are volatile and meant for people with long horizon.

Value Funds

All value managers buy stocks that they believe are worth significantly more than the current share price, but they tend to argue about just what makes a stock a good deal. How a manager defines value will determine what his or her portfolio includes and, ultimately, how the fund performs.

Fund managers practicing relative-value strategies compare a stock's price ratios (such as price/earnings, price/book, or price/sales) with a benchmark and then make a decision about the firm's prospects. Then there are managers who try to figure out what a company is worth in absolute terms, and they want to pay less than that figure for the stock. Absolute-value managers determine a company's worth using a variety of factors, including the company's assets, balance sheet, and likely future earnings or cash flows. They may also study what private buyers have paid for similar companies.

Value stocks are often the stock of mature companies that have stopped growing and that use their earnings to pay dividends . Thus value funds produce current income (from the dividends) as well as long-term growth (from capital appreciation once the stocks become popular again). They tend to have more conservative and less volatile returns than growth funds. Value funds also have categories based on market caps.

Sector-Fund Investing

The power of focusing is the principle behind sector funds, mutual funds that invest in a specific industry. How powerful can sector investing be? At the end of 1999, nine of the 10 funds with the best 10-year returns were technology funds.

Investors have many sector funds to choose from, spanning eight different Morningstar categories: communications, financials, healthcare, natural resources, precious metals, real estate, technology, and utilities. Some sector funds focus more narrowly, homing in on a particular subsector of an industry such as FSMEX that focuses on medical instruments subsector of medical sector funds.

It can be so tempting to dive into a part of the market that you think will soar based on some trend, an analyst's recommendation, or your gut.  In general, sector funds are more volatile and risky than mutual funds that invest their assets across a wide variety of industries. Reserve a very small slice of your portfolio—say 5% or less—for such activities and make sure the remainder of your portfolio is well-diversified and designed to meet your long-term investment goals with a level of risk that is acceptable to you.

Focused Funds

There is no standard definition for focused funds. The most common reference point is the number of individual stocks a fund holds. Generally, a focused fund will hold fewer than 40 stocks, and some of the most focused funds, such as Oakmark Select OAKLX, hold just 20 names. Numbers aren't everything: A fund can also be considered focused if it concentrates a large percentage of its assets in its top five or 10 holdings. Some funds concentrate in only one or a few market sectors.

If you think your investment portfolio could use a focused fund, look for the following qualities before you buy.

Ø       Experienced management Because so much rides on the individual stocks in a focused fund's portfolio, it is crucial that you look for a fund run by a seasoned manager.

Ø       Strong long-term performance You may be attracted to a focused fund because of a great quarter or sensational year. But because focused funds are linked so tightly to a few stocks or sectors, most of them will have a few glory days. Instead, look for a fund that has done well over time.

Maverick Funds

Legendary fund manager Peter Lynch would take some heat today. The former head of Fidelity Magellan FMAGX was an opportunist. Sometimes he liked growth stocks. Other times, value investments held more allure. Large companies struck his fancy but so did smaller firms. But flexible funds have their downside: They can make building a portfolio tricky. After all, if a fund is a small-cap fund one day and has large-company tendencies the next, how can investors be sure they're really diversified? Do you think we should categorize Fairholme (FAIRX) in this?

Bond Funds

These funds are more of fixed income style fund. The bond funds distinguish among each other on the basis of the credit quality and the duration of the bonds it owns.

Bond fund interest-rate sensitivity can be categorized into three groups: limited, moderate, and extensive. In previous lessons, we explained that short-term (or limited) bond funds are the least affected by interest-rate movements and thus the least volatile; long-term (extensive) funds are the most volatile. Credit quality of bond funds can also be broken into three groups: high, medium, and low. A fund's placement is determined by the average credit quality of all the bonds in its portfolio, and also adjusts for the fact that default rates increase more rapidly between lower grades than higher grades. Funds with high credit qualities tend to own either U.S. Treasury bonds or corporate bonds whose credit quality is just slightly below that of Treasuries. On the other hand, funds with low credit quality own a lot of high-yield, or junk, bonds. Medium-quality funds fall between the two extremes.

Risk in Bond Funds

Ø       Duration helps in evaluating the fund’s sensitivity to interest rate risk.

Ø       Volatility, a measure of the vraition in a bond fund’s return relative to the average taxable or tax-exempt bond fund.

Ø       Portfolio’s average credit quality.

Beware of two things when buying bond funds in general

Ø       Because bonds typically gain less than stocks over time, their costs become a heavier burden. Costs are the most important factor when evaluating bond funds, hands down.

Ø       Note that, in addition to their expenses, high-cost bond funds often take on more risk than low-cost bond funds. Expenses get deducted from the income the fund pays to its shareholders, so dwindling capital but higher yield is big no-no.

So what types of bond funds can I buy

Short/Intermediate Term US Government/Corporate Bond Funds

For your first—and maybe only—bond fund, consider intermediate-term, broad-based, high-quality bond funds that hold both government and corporate bonds. Remember, funds favoring high-grade bonds with far-off maturities can be pretty volatile, depending on what interest rates do. So when interest rates rise as they did in 2006 or they will in 2013 then favour short term bonds and when interest rates fall shifht your focus towards intermediate term bond funds.

Muni Bond Funds

Investors in the highest tax bracket may profit most from municipal bonds' tax-exempt status. Unlike income from bonds issued by corporations or the federal government, income generated by municipal bonds is exempt from federal and sometimes state income taxes. So when examining a municipal bond's yield, you must take the implicit tax advantage into account. The intermediate-term and long-term municipal-bond fund categories have returned roughly the same (4.7% annualized) over the trailing 10 years through 2010. But the intermediate-term muni category has had less volatility. Also try to stick with munis with average credit qualities of AA. They have enough high-quality bonds to skirt most credit scares but are still flexible enough to snap up higher-yielding, lower-rated issues. You don’t want to take the Harrisburg route.

High Yield Junk Bond Funds.
If you are looking to expand your bond-fund horizons, high yield may be the first area you've considered. High-yield bonds are often called lower-quality bonds, or junk bonds. No matter the name, these bonds offer much more income than Treasuries or other high-quality corporate bonds. That's because they have more credit risk.

Junk bonds pay higher yields and are often denominated in shorter maturities, they aren't as sensitive to interest-rate shifts as higher-quality, longer-duration bonds are. The junk bond can get hurt badly when number of companies are filing for bankruptcies such as the Lehman Brother’s turmoil. Similarly Worldcom's bankruptcy roiled the high-yield market.

Treasury Inflation-Protected Bond Funds

Treasury Inflation-Protected Securities (or TIPS) are issued by the U.S. government and are designed to offer protection against the ravages of inflation. Unlike regular Treasuries, TIPS promise investors that their principal value will rise in lockstep with the Consumer Price Index. That guarantees investors' principal will keep up with inflation, and because TIPS' coupon payments, which are just the real yield, are still calculated as a percentage of that principal amount, their value can move up with inflation as well. But it is important to understand that TIPS do not directly offer protection from rising interest rates. Interest rates and inflation rates don't have to move in unison, and if rates spike without a corresponding rise in inflation, TIPS can suffer a loss.

Rule of Thumb for Bond Funds.

Common sense would dictate making bond fund selections primarily from among funds in the lowest-cost quartile, the better to maximize the chances of enjoying returns above segment norms. The lowest cost group had not only the highest returns, but also the lowest risks. The returns go down as the costs go up. In fact each percentage point reduction in cost , on average , increased the returns by over 1.2 percent for an average bond fund.

Funds of Funds

Funds of funds are mutual funds that invest in other mutual funds. That may sound redundant, but it's true. Just as a regular mutual fund offers the skills of a professional manager who assembles a portfolio of stocks or other securities, the manager of a fund of funds will select a portfolio of funds, managed by other managers. If you have only a small amount to invest each month, a fund of funds allows you access to more funds than you might be able to afford on your own. It also allows investors to avoid the recordkeeping and paperwork that comes with owning an assortment of funds.

So what's the catch? Expenses, mostly. The fund of funds structure creates a double layer of costs.

Fund Costs

Mutual Fund companies are not running charity and they have to ensure that they make money. For this reason, all mutual funds charge fees, but these charges for mutual funds come right off the top of your investment or straight out of your returns. Because costs are deducted this way, many investors aren't even aware of how much they're paying for their mutual funds.

Fund’s expense ratio can range from 0.2 percent of assets annually for the lowest caost equity fund to 2.5 percent for highest cost equity fund. So the question here is – Does a percentage point or so really matter?

Fund’s Total Return – Cost = Fund’s Actual Investor return.

Years	High Cost 10% Return	Low Cost 11.9% Return
10	25900	30800
25	108300	166200
50	1173900	2763800

In fact each percentage point reduction in cost, on average, increased the returns of a bond mutual fund by over 1.2 percent and increased the returns of large cap blend mutual fund by 1.8 percent. Before you invest in a fund, you should look at the expense ratio that they charge because costs really matter and they can take bite off your returns.

Mutual fund fees can be broken down into two main categories: one-time fees and ongoing annual expenses. Not all funds charge one-time fees, but all funds charge ongoing annual fees of some sort.

One Time Fees

1.     Sales Commission A.K.A. Loads.

If you have to pay a sales charge, or commission, when you purchase shares in the fund, that's known as a front-end load; a sales charge when you sell is a back-end load. Loads come directly out of your investment, effectively reducing the amount of money that you're putting to work. For example, if you made a $10,000 investment in a fund that carried a 4.5% front-end load, only $9,550 would be invested in the fund. The remaining $450 would go to the advisor or broker who sold you the fund.

But do load funds offer superior returns in order to justify the expense of the load? There is no evidence to suggest that this is the case. However, you probably shouldn't just disregard a mutual fund because it has a load. On the stock side, a load fund may make a perfectly fine investment, if you're a long-term investor. But load-fund investors should look for funds with fairly low annual costs, such as those sponsored by American Funds. Their total costs (including sales fees) over a period of years are actually more moderate than those of many no-load funds.

2.     Redemption Fees.

Redemption fees differ from loads in that they are usually paid directly to the fund—in other words, they go back into the pot rather than to the broker or advisor. You may have to pay a redemption fee if you hold a fund for only a short period of time. In most cases, this time frame is less than 90 days, but it can be as long as a few years. These fees are an attempt to discourage short-term traders from moving in and out of a fund and that it enables the fund managers to invest the money more confidently, without having to keep a large amount of cash reserves ready for redemptions.

3.     Account-Maintenance Fees.

Some fund companies charge account-maintenance fees, but such fees are usually for smaller accounts. Vanguard funds, for example, charge shareholders a $10 account-maintenance fee if their account balances dip below $10,000, Trowe Price has some charge, etc.

4.     Transaction Fees.

Some brokers and fund companies charge transaction fees specially if you buy a fund that is not the product of the company e.g. TD Ameritrade charges 50$ for some funds, Scottrade charges 17$ for some, etc.

Ongoing Expense

1.     Management Fees.

Mutual funds charge management fees in order to pay for the management services used to run the fund. In other words, these fees are used to pay the salaries of the fund's managers and analysts. Management fees usually do not amount to more than one percent of the fund's assets, and they are significantly lower for passively-managed funds, such as index funds, than for actively-managed ones . You should remember that a high management fee in no way guarantees a more skillful management team.

2.     12b-1 Fees.

12b-1 fees, also sometimes called "distribution fees", pay for any marketing and advertising expenses that the fund incurs. They are called 12b-1 fees because that is the number of the SEC rule that allows mutual funds to charge them. No-load mutual funds often have higher 12b-1 fees because they do not charge sales commissions. You should always look at 12b-1 fees in conjunction with sales load.

3.     Interest Expense.

If a fund borrows money to buy securities—not a very common practice among mutual funds—it incurs interest costs. This is particularly common in mutual funds that engage in long/short strategies. Such expenses are also taken out of the shareholders' annual return.

So the bottom line is that the cost matters. With risk constant the high returns are directly associated with low cost. In large cap blend fund the average risk adjusted return provided by low cost fund is 24 percent higher than that of high cost fund. 

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Know Your Fund

The experience of the last five years suggests that investors need more than performance numbers and hot tips to judge a fund. Before parting with your money, you need to be able to answer questions such as: What is the fund's investment strategy? What are that strategy's risks? How much does the fund cost? How does this fit in with my goals? And who runs the thing, anyway?

In order to answer these questions you need three valuable fund documents, produced by the company running your mutual fund: the prospectus, the Statement of Additional Information, and the annual report. You get all these documents and other relevant information on fund companies Web sites.

Lets try to extract the pertinent information from the documents –

The Prospectus

The prospectus tells you how to open an account (including minimum-investment requirements), how to purchase or redeem shares, and how to contact shareholder services. It also details six aspects of the fund that you need to know about before you decide to buy shares.

1. Investment Objective.

The investment objective is the mutual fund's purpose. Is the fund seeking to make money over a long-term period? Or is it trying to provide its shareholders regular income each month? ou should check to see whether or not the fund's objectives match your own personal investment objectives, since you probably only want to invest in funds that have similar goals to your own. 

2. Strategy.

The prospectus also describes the types of stocks, bonds, or other securities in which the fund plans to invest. Stock funds spell out what kinds of companies they look for, such as small, fast-growing firms or big, well-established corporations. Bond funds specify what sorts of bonds they generally hold, such as Treasury or corporate bonds.

3. Risks.

This section may be the most important part of the prospectus, but it's generally written in very broad language. Every investment has risks associated with it, and a prospectus must explain these risks. For example risks associated with small cap companies, foreign companies, and lower quality bonds.

4. Expenses.

It costs money to invest in a mutual fund, and different funds have different fees. This will help you check out various kind of fees the fund charges such as management fees, redemption fees, various kinds of sales commission the company charges (loads), etc.

5. Past Performance.

The prospectus has chart known as the "Financial Highlights" or "Per-Share Data Table" that provides the fund's total return for each of the past 10 years, along with some other useful information. It also breaks out the fund's income distributions and provides the year-end NAV. The prospectus may also use a growth of $10,000 graph or a table comparing the fund's performance to indexes or other benchmarks to present return information. Unless otherwise stated, total return numbers do not take sales charges into account, but they do take into account a fund's annual expense ratio.

6. Management.

The Management section profiles the folks who will be putting your money to work. At this point, many funds identify the name and experience of the fund manager or managers.

Annual Shareholder Report

You should use these annual reports to check whether or not your fund is performing according to your expectations. The reports include a list of the fund's financial statements, a list of the fund's securities, letters from president and fund mananger. A good shareholder report is like a biography in that it sets out what happened to the fund over the past quarter, six months, or year, and why. It's like a blueprint because it sets before you all the investments—stocks, bonds, and other securities—that the fund has made.

Fund Performance

The report should compare your fund's performance to both a benchmark, such as the S&P 500 Index (the standard benchmark for large-company stock funds) or the Russell 2000 Index (for small-company funds), as well as to the average performance of funds with similar investment strategies. You should check to see whether or not your fund managed to beat its peers

When evaluating your fund's performance, be sure that the benchmark the fund chooses is appropriate for its style. For example, a technology fund shouldn't compare itself to the Dow; it should measure its performance against a technology benchmark.

In addition to benchmark comparison, the report should give you an idea of how the fund has performed over various time frames, both short and long term.

Letter from the Portfolio Manager

This is a fund-specific examination of the recent performance—and therefore much more important to you as a fund shareholder. Well-written shareholder letters discuss individual stocks that the fund owns and the industries in which the fund invested. A good manager letter will also explain what broad market trends might have fueled or hindered your fund's performance.

Portfolio Holdings

Funds often list the portfolio's largest holdings and provide some information about what these companies do or why the manager owns them. Some reports will also indicate, via a pie chart or table, the sectors in which the fund is heavily invested.

Financial Statements

A fund's annual report concludes with its financial statements. Brace yourself: There's a lot of data here. In fact, this is where Cost-conscious investors get a lot of the data before calling shots.

You should take a look at the following: First, examine what's known as the fund's Selected Per-Share Data. This is usually the last page of actual information, located just before the legal discussion of accounting practices. Here you'll find the fund's NAVs, expense ratios, and portfolio turnover ratios for each of the past five years (or more). Check to see if the fund's expense ratio has gone down over time and whether its turnover rate has changed much.

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What Is Mutual Fund?

A mutual fund is a security offered by a company which pools money from investors and invests it using a predefined strategy involving certain stocks, bonds and other assets. By pooling their money together, mutual fund investors can sample a broader range of stocks or bonds than they could if they were trying to buy the stocks and bonds on their own. Each investor in the fund owns shares representing some fraction of the collective holdings of stocks, bonds or other assets comprising the portfolio. In general funds can be divided into following two groups:

Acitvely-Managed Funds

Portfolios in actively-managed funds are managed on a day-to-day basis by a team of professionals—usually under the direction of one or two managers—which makes buy, hold and sell decisions with the goal of maximizing shareholder return.

Index Funds

The portfolio in an index fund—and its performance—is designed to mimic that of a specific market index (e.g., S&P 500 Index). Professional management efforts for an index fund are aimed at producing a rate of return that closely matches the index by ensuring that the allocation of assets in the fund portfolio is in alignment with that of the index at various times throughout the year. The rarity of change in portfolio, ranging from 15 to 25 equities, makes the index funds a passive investment vehicle.

Passive VS Active Funds

One argument for index funds is that they annually outperform a majority of actively-managed mutual funds. That’s true. However, they also annually underperform a number of fund managers. Every year, some actively-managed funds outperform various broad market indices and other more defined stock market indices. Some funds have a demonstrated history of solid performance for extended time periods.

Another argument for the use of index funds is that investors normally pay lower operating expenses. Proponents of actively-managed funds counter by saying funds which generate above-market returns for shareholders can offset the added expenses through performance.

There are two other broad categories of mutual funds -

  

Closed-End Funds 

This type of fund has a set number of shares issued to the public through an initial public offering. These shares trade on the open market; this, combined with the fact that a closed-end fund does not redeem or issue new shares like a normal mutual fund, subjects the fund shares to the laws of supply and demand. As a result, shares of closed-end funds normally trade at a discount to net asset value.

Open-End Funds
A majority of mutual funds are open-ended. In simple terms, this means that the fund does not have a set number of shares. Instead, the fund will issue new shares to an investor based upon the current net asset value and redeem the shares when the investor decides to sell. Open-end funds always reflect the net asset value of the fund's underlying investments because shares are created and destroyed as necessary. All the lessons posted on fund 101 are related to open end funds.

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Why Mutual Fund?

Pros

It may not be obvious at first why you would want to purchase shares in different securities through a mutual fund "middleman" instead of simply purchasing the securities on your own. The mutual funds offer notable benefits to investors.

Ø      All Eggs in one basket:

The mutual funds give you ability to diversify in number of assets with limited capital. With a mutual fund you can diversify your holdings both across companies (e.g. by buying a mutual fund that owns stock in 100 different companies) and across asset classes (e.g. by buying a mutual fund that owns stocks, bonds, and other securities). When some assets are falling in price, others are likely to be rising, so diversification results in less risk than if you purchased just one or two investments.

Ø      Funds Galore:

Mutual funds are available in several styles and types. Balanced funds, bond funds, money market mutual funds, stock funds, and target-date mutual funds are different types of mutual funds available. There are thousands of funds, and each has its own objectives and focus. The key is for you to find the mutual funds that most closely match your own particular investment objectives.

Ø      Mutual Funds are liquid assets:

Liquidity is the ease with which you can convert your assets--with relatively low depreciation in value--into cash. In the case of mutual funds, it's as easy to sell a share of a mutual fund as it is to sell a share of stock

Ø      No Large upfront investments:

Most mutual funds will allow you to buy into the fund with as little $1,000 or $2,000, and some funds even allow a "no minimum" initial investment, if you agree to make regular monthly contributions of $50 or $100. Whatever the case may be, you do not need to be exceptionally wealthy in order to invest in a mutual fund.

Ø      Systematic Investing and Additional Services:
It is easy to invest frequently in a mutual fund. Several mutual fund firms lets their investors to invest money as low as USD 100/month to their mutual fund. Your amount can be withdrawn directly from your bank account and then deposited to your mutual fund. It will work the other way around as well, money from mutual fund can also be transferred to your bank account. This service comes at free of cost. Some mutual funds offer additional services to their shareholders, such as tax reports, reinvestment programs, and automatic withdrawal and contribution plans. 

Ø      Low Transaction Costs:

Mutual funds are able to keep transaction costs -- that is, the costs associated with buying and selling securities -- at a minimum because they benefit from reduced brokerage commissions for buying and selling large quantities of investments at a single time.

Ø       Regulation:

Mutual fund managers can't take your money and head for some remote island somewhere. Thanks to the Investment Company Act of 1940 (often called "the '40 Act"), your mutual fund is a regulated investment company (regulated by the Securities & Exchange Commission) and you, as a mutual fund investor, are an owner of that company.

Ø Professional Management:

While mutual fund investors should have a basic understanding of how the stock and bond markets work, you pay your fund managers to select individual securities for you. You don’t need in-depth financial knowledge to invest in Mutual Funds. Mutual funds are managed by a team of professionals, which usually includes one mutual fund manager and several analysts. Presumably, professionals have more experience, knowledge, and information than the average investor when it comes to deciding which securities to buy and sell

Cons

Still, mutual funds are not fairy-tale investments. As you will learn in later sessions, some funds are expensive and others perform poorly. You should also be aware of the drawbacks associated with mutual funds.

Ø    No Insurance:

Mutual funds, although regulated by the government, are not insured against losses. The Federal Deposit Insurance Corporation (FDIC) only insures against certain losses at banks, credit unions, and savings and loans, not mutual funds. That means that despite the risk-reducing diversification benefits provided by mutual funds, losses can occur, and it is possible (although extremely unlikely) that you could even lose your entire investment.

Ø      Dilution:

Although diversification reduces the amount of risk involved in investing in mutual funds, it can also be a disadvantage due to dilution. For example, if a single security held by a mutual fund doubles in value, the mutual fund itself would not double in value because that security is only one small part of the fund's holdings. By holding a large number of different investments, mutual funds tend to do neither exceptionally well nor exceptionally poorly. 

Ø    Fees and Expenses:

Most mutual funds charge management and operating fees that pay for the fund's management expenses (usually around 1.0% to 1.5% per year). In addition, some mutual funds charge high sales commissions, 12b-1 fees, and redemption fees. And some funds buy and trade shares so often that the transaction costs add up significantly. Some of these expenses are charged on an ongoing basis, unlike stock investments, for which a commission is paid only when you buy and sell.

Ø       Poor Performance: Returns on a mutual fund are by no means guaranteed. In fact, on average, around 75% of all mutual funds fail to beat the major market indexes, like the S&P 500, and a growing number of critics now question whether or not professional money managers have better stock-picking capabilities than the average investor. 

Ø      Loss of Control:

The managers of mutual funds make all of the decisions about which securities to buy and sell and when to do so. This can make it difficult for you when trying to manage your portfolio. For example, the tax consequences of a decision by the manager to buy or sell an asset at a certain time might not be optimal for you. You also should remember that you are trusting someone else with your money when you invest in a mutual fund. 

Ø     Trading Limitations:

Although mutual funds are highly liquid in general, most mutual funds (called open-ended funds) cannot be bought or sold in the middle of the trading day. You can only buy and sell them at the end of the day, after they've calculated the current value of their holdings. 

Ø      Size:

Some mutual funds are too big to find enough good investments. Larger the fund less nimbe it is, This is especially true of funds that focus on small companies, given that there are strict rules about how much of a single company a fund may own. If a mutual fund has $5 billion to invest and is only able to invest an average of $50 million in each, then it needs to find at least 100 such companies to invest in; as a result, the fund might be forced to lower its standards when selecting companies to invest in. 

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