Downsides to Stock Market Mutual Funds

Stock market mutual funds are investment vehicles that you can use to earn profits over a period of time. In the long run, mutual funds have been known to outperform other types of investments. However, this type of investment is not without risk and a good number of people who put their money into this type of investment have lost their money. Below are some of the downsides to stock market mutual funds that you need to look into before you put your hard earned money into this investment vehicle.

No Insurance Coverage

Stock market mutual funds are usually not insured, so your investments have very limited protection. Note that prices in the stock market are volatile and values fluctuations are normal so insurance companies do not cover stock market mutual funds. Since your investments are not insured, during economic downturns when the prices of stocks generally go down, you lose money and may not be able to recover that money unless you keep your stocks and wait for the market to recover. If the market does not recover in time and the company who issued the stocks goes bankrupt, you will not be able to recover the cost of your investment. Yes, the whole idea of losing all your investment sounds scary, but the good news is that since mutual funds allow you to invest your money in a diversified portfolio, you may not actually go empty handed in the end.

Diversification lowers the Income Potentials

Although diversification can spread and reduce the risk, this can also lower your income potential. Note that not all stocks are created equal and some stocks tend to perform better than the others. In the event where half of the stocks in your portfolio do not perform well while the others are doing well, you will still not earn much. Note that the earnings you get from good performing stocks will be offset by the losses you incur from poor performing stocks, so in the end, you only earn a little, or worse, you may even lose some money.

Unstable Income

If you invest in common stocks, you are at the mercy of the market forces. Prices in the stock market are volatile and there is no guarantee that an investment portfolio that raked in a lot of profits in the previous year will perform well this year. Always remember that prices are driven by a number of factors, including market conditions, so when market conditions shift for the worse, your stocks may lose some of their value. On the other hand, if you invest in preferred stocks with fixed interest rates, you will not be able to enjoy income flexibility. Since the value preferred stocks have limited potential to appreciate, you could get stuck with low-rate preferred stocks and end up losing money.

Fund Management Cost

Stock market mutual funds charge management fees to cover the cost of administration. Even if you did not earn money on your investment for the year, your fund manager may still charge you for managing your funds. Also, if you withdraw your investment after a short period of time, your funds manager may charge a redemption fee to cover administration costs.