What are the Con Arguments against Return on Investing in Mutual Funds for Diversification

There’s good reasons to invest in mutual funds – but there’s also some good reasons not to! The basic idea behind mutual funds is that they offer investors a widely-diversified bundle of stocks, all selected by experts with a panel of researchers. This shelters the investor from sudden drops in the value of any one stock, since they’re balanced out by the returns of all the other stocks in the mutual fund. Unfortunately, this makes it hard to keep track of what exactly you’re investing your money in. So if you’re not careful, you could end up with a portfolio that actually less diversified!

For example, many financial advisors will advise you to invest in both small companies and large companies, and to invest some of your money in the stock of companies that are overseas. (That way your portfolio enjoys the benefit of diversification if there’s suddenly a negative trend that affects a certain sector of the economy.) Unfortunately, you can’t always control how the mutual funds will invest your money. Over time their stock pickers could decide to shuffle your investments around, moving them into different countries or into different-sized companies. Instead of the diversification you thought you were achieving, you end up overweighted!

And this is an even bigger problem when you’re investing in more than one mutual fund, since both funds could move in the same direction, doubling your investment in a sector which could be headed for trouble. Of course, this doesn’t have to happen, if you closely monitor the fund’s statements about how they’re distributing your investments, but most investors don’t want to take the time to do this. And adopting that strategy means you’re sacrificing the ease and simplicity that mutual funds were supposed to provide!

Obviously, one way to avoid this problem is investing in mutual funds with a very specific investment objective – for example, a fund which only invests in a specific company, or which only invests in companies below a certain market capitalization. Of course, this means you’re then choosing your own “mix” of stocks, which makes you responsible for much of the diversification that the mutual fund was supposed to provide. Then you’re actually making very specific bets on specific industries or sectors of the economy. This can be a practical strategy, but only if you understand everywhere that you need to invest to achieve a full diversification of your portfolio.

Otherwise, there’s always a chance that investing in a mutual fund can do more harm than good!