Disadvantages of mutual funds

Mutual fund is viewed as one of the perfect investment options available for small investors with little market exposure. They offer risk reduction, diversification, professional management, convenience, liquidity etc. But this doesn’t mean that you need not do your home work. Here are some of the important disadvantages of mutual funds.

1. Diversification dilutes return and there can be over diversification.
2. There are no guaranteed returns.
3. Fund manager may be tempted to show good results in the short term at the expense of long term performance as the manager’s compensation is based on the fund’s performance.
4. Mutual fund portfolios are not tailor made
5. The annual fund operating fee is charged irrespective of the fund’s performance
6. To maintain liquidity mutual funds keep a large portion of their portfolio as cash and this put pressure on the fund’s return.
7. Investors have no choice or control over the selection of securities.
8. Performance of fund manager is vital.

An interesting case study regarding fund manager putting investor’s money at stake is summarized (for details please refer http://www.sec.gov/news/press/2004-157.htm)

Gary Pilgrim the fund manager of PBHG growth fund made profits while the investors lost heavily. He invested in a Hedge Fund maintained by his friend and profited by betting against the PBHG. So while the investors lost heavily Gary made huge return from the fall.