What are the advantages and disadvantages of mutual funds compared to investing in individual stocks?
The biggest advantage is diversification, or spreading of risk. A mutual fund is typically invested in scores, and sometimes hundreds of stocks or bonds, and this can reduce risk to the investor, who may otherwise be forced to invest in a small number of stocks or bonds due to dollar limitations. Two other advantages are professional management provided by the fund company, and ease of buying and selling shares of the fund. The disadvantages may include over diversification of a portfolio, rather than concentration in one or more stocks. This can dilute potential returns. In addition, mutual fund investors are unable to control the tax consequences involved in transactions made by the mutual fund.
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