Mutual funds have been gaining popularity across various investor categories in recent years. However, it seems like these investment vehicles are more appealing to small investors than any other category. Why is that?
Here are some reasons why mutual funds are attractive to small investors:
- Mutual funds have relatively low minimum investment sizes.
- Mutual funds provide professional portfolio management.
- Mutual funds make it possible to diversify with less money.
- Mutual funds are cost-effective to trade.
- You can access specialized market sectors with mutual funds.
- Mutual funds allow dividend reinvestment.
Let’s take a close look at each of these benefits in the rest of this article. If you’re interested in mutual funds and want to know if it’s an option for you, you’re in the right place.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
Mutual Funds Have Relatively Low Minimum Investment Sizes
One of the main selling points of mutual funds is that they require a relatively low initial outlay. Most funds will only require investors to raise a capital of $500 to $3000 to get started.
However, brokers have lower minimums. Some offer funds for as little as $100, and others have no limits to how much you need to get started.
It’s also worth mentioning that once you’ve met the minimum capital requirement, there are no limits to how much you can invest going forward. For instance, if your fund’s minimum is $500 and you raise that for the initial outlay, you can invest as little as $10 the next month.
This kind of flexibility is essential for small investors with inconsistent income streams. It means they can invest as little as they can raise when money is tight and as much as possible when things get better.
Mutual Funds Provide Professional Portfolio Management
Successful securities trading involves a lot of research, data analysis, and decision-making. These activities require time and expertise, things that small investors may not always have.
Mutual funds take the bulk of the work off your hands. Provided you choose a fund with a great track record, you can profit without being involved in the daily intricacies of managing the securities you’ve invested in.
The fund manager (or benchmark index if you choose an index fund) will handle all of that for you. They’ll be hands-on with the daily buying and selling decisions to ensure that all the financial instruments held in the fund are managed as per the fund goals. This frees up a significant chunk of your time, allowing you to focus on other ways of growing your money.
It’s also pretty useful that each mutual fund reveals its investment strategy and goals to investors beforehand. This information is usually provided in the fund’s prospectus and allowing investors to review it before investing helps them pick funds that align best with their risk appetite.
Having the option to pick a fund according to risk tolerance is particularly helpful for small investors because it means they can choose low-risk funds to protect their limited capital.
Mutual Funds Make It Possible To Diversify With Less Money
Diversification is one of the most critical principles of sound investment. You want to invest your money in different companies and industries such that if a particular company or industry fails, you won’t lose everything. That, albeit in somewhat oversimplified terms, is how diversification works.
However, diversification doesn’t always come on the cheap, especially if you’re trading securities as an independent investor. Why? Because optimum diversification requires you to hold about 20 to 30 different securities in your portfolio.
Using stocks as an example, you’d need a sizable budget to purchase ownership stakes in 20 or more different companies. Given that stocks of high-performing companies usually come at a premium, you’d need an even more significant amount to diversify your portfolio with high-quality stock.
Mutual funds eliminate this hurdle to portfolio diversification.
A typical mutual fund will hold more than 30 securities in its portfolio. Some may hold more than 500 securities: funds that track the S&P 500 are perfect examples of this. So when you invest $500 in a mutual fund, for instance, you buy into a pool of diversified investments, cost-effectively lowering your risk.
And since mutual funds diversify across countries, sectors, and industries, you can diversify further by creating a portfolio of mutual funds with varying security types from different industries, geographical locations, and sectors.
As a starting point, you could invest in two or three different mutual funds and work your way up. This shouldn’t require too much capital, especially if you’re dealing with a broker with low minimums.
Mutual Funds Are Cost-Effective To Trade
A typical mutual fund’s trading costs are lower than those of ETFs. This has a lot to do with the fact that mutual funds typically trade at their Net Asset Value (NAV), which is essentially its per-share market value.
The fact that mutual funds trade their NAV has two benefits as far as cost reduction is concerned:
- It means that a bid/ask spread doesn’t apply to mutual funds. With a single price per day, all traders can buy/sell at a uniform price.
- When the price is the per-share market value, investors don’t have to worry about paying a premium for the fund.
In contrast, ETFs don’t always trade at their NAV一they can trade above or below it. This is particularly true for smaller ETFs. Deviating from the NAV makes ETFs more likely to have wide bid/ask spreads and increases your chances of paying premiums or (if you’re lucky) discounts.
Mutual funds’ lower trading costs can also be attributed to the sheer fact that investors share expenses. When multiple investors pool resources together in a fund, they cut transaction costs and improve operational efficiency through economies of scale.
When trading individual stocks, you shoulder all your transaction costs on your own. These can add up pretty quickly, more so if you buy stocks in small amounts or dollar-cost average. You may also open yourself up to bid-ask spreads.
A quick tip: To minimize costs, consider no-load funds with low expense ratios. Examples include Fidelity, Vanguard, and T. Rowe Price.
You Can Access Specialized Market Sectors With Mutual Funds
Thanks to their ability to analyze and execute complex strategies, mutual funds can be an excellent way for small investors to venture into specialized market sectors without risking too much or investing a fortune.
A single investment in a specialty mutual fund gives you access to market sectors that may be too costly or logistically impossible to access with a Separately Managed Account (SMA). And that’s not to mention that specialty mutual funds’ investment minimum is usually a fraction of that of an SMA.
Mutual Funds Allow Dividend Reinvestment
For many small investors, growing their investment is a bigger priority than short-term earnings. The rationale is that the more you grow your investment now, the more likely you are to earn higher returns in the future.
Dividend reinvestment plans are one of the best ways to grow your investment on “autopilot.” How they work is pretty simple: whenever dividends get paid out, you choose to reinvest them instead of receiving the payout. As more dividends get paid with time, the more you grow your capital without investing anything out-of-pocket.
Setting up dividend reinvestment plans is straightforward with both mutual funds and brokers. All you need to do is notify your fund company or broker of your intent to reinvest your earnings, and they’ll keep doing that until otherwise instructed.
Author’s Recommendations: Top Trading and Investment Resources To Consider
Before concluding this article, I wanted to share few trading and investment resources that I have vetted, with the help of 50+ consistently profitable traders, for you. I am confident that you will greatly benefit in your trading journey by considering one or more of these resources.
- Roadmap to Becoming a Consistently Profitable Trader: I surveyed 5000+ traders (and interviewed 50+ profitable traders) to create the best possible step by step trading guide for you. Read my article: ‘7 Proven Steps To Profitable Trading’ to learn about my findings from surveying 5000+ traders, and to learn how these learnings can be leveraged to your advantage.
- Best Broker For Trading Success: I reviewed 15+ brokers and discussed my findings with 50+ consistently profitable traders. Post all that assessment, the best all round broker that our collective minds picked was M1 Finance. If you are looking to open a brokerage account, choose M1 Finance. You just cannot go wrong with it! Click Here To Sign Up for M1 Finance Today!
- Best Trading Courses You Can Take For Free (or at extremely low cost): I reviewed 30+ trading courses to recommend you the best resource, and found Trading Strategies in Emerging Markets Specialization on Coursera to beat every other course on the market. Plus, if you complete this course within 7 days, it will cost you nothing and will be absolutely free! Click Here To Sign Up Today! (If you don’t find this course valuable, you can cancel anytime within the 7 days trial period and pay nothing.)
- Best Passive Investment Platform For Exponential (Potentially) Returns: By enabling passive investments into a Bitcoin ETF, Acorns gives you the best opportunity to make exponential returns on your passive investments. Plus, Acorns is currently offering a $15 bonus for simply singing up to their platform – so that is one opportunity you don’t want to miss! (assuming you are interested in this platform). Click Here To Get $15 Bonus By Signing Up For Acorns Today! (It will take you less than 5 mins to sign up, and it is totally worth it.)
Affiliate Disclosure: We participate in several affiliate programs and may be compensated if you make a purchase using our referral link, at no additional cost to you. You can, however, trust the integrity of our recommendation. Affiliate programs exist even for products that we are not recommending. We only choose to recommend you the products that we actually believe in.
