When you want to invest in a mutual fund, you might be required to put forward a particular figure before you can be allowed to buy any shares. Sometimes, this can prevent you from investing in a fund that you’d otherwise be able to afford a handful of its shares. So, why do mutual funds have a minimum investment?
Mutual funds have a minimum investment to help attract the right types of clients, streamline their operations, and regulate the number of investors. A minimum investment can also be a means to ensure that the fund sticks to its investment strategy and delivers on its promises to investors.
The rest of this post will explore the purpose of a minimum investment in a mutual fund in greater detail. But before we get to that, we’ll discuss what a minimum investment means in a mutual fund. Let’s get started!
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Table of Contents
What Is a Minimum Investment in a Mutual Fund?
This term can mean slightly different things depending on the type of investment in question.
The minimum investment in a mutual fund is the least amount of money you’d need to put forward to be allowed to buy a security in some fixed-income securities (like corporate bonds), Limited Partnerships (LPs), and Collateralized Mortgage Obligations (CMOs).
However, a mutual fund’s minimum investment can mean more than just a specific dollar amount. While many funds do set their minimums in cash terms, some also have theirs in share amounts.
But now you might be wondering: isn’t a minimum investment set via share quantity the same as one set in a dollar amount? After all, you can always turn shares into cash and vice versa, right?
There’s a difference. For instance, if the minimum investment is ten shares, their cash equivalent may change with time due to market forces and distributions.
This means that if you bought these shares immediately after the fund’s Net Asset Value (NAV) has dropped in a certain period, you’d need a smaller cash equivalent than if you purchased the same fund’s shares when its NAV was soaring.
Why Do Mutual Funds Impose a Minimum Investment?
Mutual funds impose a minimum investment for varying reasons, including:
- To attract and maintain suitable types of clients
- To streamline operations
- To regulate the number of investors in the fund
- To comply with the funds’ investment strategy as outlined by the prospectus
Let’s review how having a minimum investment may help a mutual fund achieve all of the above.
Minimum Investments Help Attract the Right Clientele
Every mutual fund caters to clients of a specific profile. For example, some are set up to attract smaller investors, while others are designed to suit the investment needs of high-net-worth individuals. In either case, the minimum will be set to reflect the kind of clientele the fund would like to attract.
Typically, funds geared towards smaller investors and the younger generation have smaller minimums. The rationale is that both investor groups tend to have limited capital and thus would be locked out of investment opportunities if the minimum is set high.
On the other hand, funds looking to attract high net worth investors set the minimums high to weed out investors with limited budgets. Likewise, those eyeing the middle class tend to have moderate investment minimums.
Understand that when a fund has low minimum investment, it doesn’t always mean that it’s looking to attract small investors. It may also appeal to investors with a sizable budget but are looking to diversify their investments by acquiring shares of multiple mutual funds.
It’s also worth noting that the minimum investment is merely one of the criteria mutual funds use to attract the ideal clientele. Other criteria may include the risk profile, investment time horizon, among others.
Minimum Investments Help Streamline Operations
Sometimes, a mutual fund may use the minimum investment as a means to regulate cash inflows.
Small, frequent, short-term trades can bog down daily asset management. Whether a given fund takes issue with this comes down to its investment style and objective. If small, frequent, short-term aren’t preferred, the fund may raise the minimum investment to deter such trades because investors looking to execute them tend to work with smaller budgets.
The other way an investment minimum may be used to streamline a mutual fund’s daily operations is by ensuring that there are enough Assets Under Management (AUM) to cover overheads.
Typically, overheads are difficult to track and attribute to a specific cost unit. As a result, mutual funds need to set aside funds to cover these, and having minimum investments helps achieve that.
Minimum Investments Help Regulate the Number of Clients
Generally, the more clients a fund has, the more the booking and other paperwork it’ll have to handle. Some funds, especially those with small management teams, might not want this, and setting a suitable minimum investment can help avoid it.
To minimize the number of clients, some funds adjust the minimum investment upwards. This locks out some investors (typically those with limited capital) and allows only a handful of investors to invest in the fund.
On the other hand, some funds may set the bar lower to attract more clients and boost the number of assets under management. When the minimum is low, it makes the fund more accessible to smaller investors. The need to attract more investors can be triggered by several factors, among them competition and expansion endeavors.
Minimum Investments Help Comply With the Investment Strategy
Part of a mutual fund’s investment strategy is choosing the right securities. Trading the suitable security types helps a fund deliver promises made to investors through the prospectus.
Pledges made to investors may vary from one fund to another. For example, some funds promise regular interest payments, risk minimization, liquidity, or dividends.
Depending on what the fund intends to deliver to its investors, it might be forced to trade high-priced securities. Bonds, for instance, can help minimize risk and provide regular interest payments.
If a fund is trading high-priced securities, its minimum investment may be set high to provide the required working capital. The reverse is also true.
What Is the Typical Minimum Investment in Mutual Funds?
The typical minimum investment in mutual funds is $500 to $3000 on average. However, minimum investment sizes can vary significantly across mutual funds, and many fall outside this range. So while funds will allow investments of as low as a couple of hundreds of dollars, others have set the bar as high as millions.
To demonstrate, let’s look at two popular offerings from Vanguard:
- Vanguard Windsor Fund Investor shares (VWNDX) – dates back to 1958 and boasts a solid long-term performance. It has a minimum investment of $3000. However, after the initial investment, there’s no limit to how much you can invest.
- Vanguard S&P Mid-Cap 400 Index Fund Institutional Shares (VSPMX) – has set the bar for the minimum investment at $5 million.
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Conclusion
Hopefully, this post has helped you understand why many funds have minimum investments. And while having a minimum can be helpful to a fund, it can also sometimes lock you out of investment opportunities.
Luckily, there are ways to bypass this challenge, including investing in EFTs and choosing funds with affordable minimums. So instead of letting your money sit idle as you wait to meet the threshold for your desired fund, talk to a financial advisor. They might be able to help you unearth opportunities you thought you’d need years to raise capital for.
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