Chapter 4, Problem 1PS

Summary Introduction

To determine:

The advantage and disadvantage of investing to small investors via mutual funds.

Introduction:

Mutual fund refers to the investment policy under which the funds are pooled from the investor and same is invested in different securities such as debentures, bonds and stocks. Mutual funds are advantageous for the small investor as it provides leverage to make investments in small amounts.

Answer to Problem 1PS

The advantage of mutual fund is the facility provided to investor to start with a small investment. The disadvantage is high sales charges and expense ratios.

Explanation of Solution

The advantage of mutual fund is it decreases the anxiety associated with investing. Most of the investor lives constantly with a specific amount of fear and anxiety with respect to their investment as they feel lack of some of the essential of investments viz. proven game plan, self discipline, investing experience and market knowledge. Another advantage of mutual fund is the leverage to invest in small amounts. The minimum amount required by most fund organizations for opening account starts with $1,000.

The disadvantages associated with mutual fund are high sales charges and expense ratios. The funds that possess expense ratio greater than 1.20% tend to have a higher cost. An investor should also take into consideration the sales charges and 12b-1 advertising fees that increase the cost of investment. Another disadvantage of mutual fund is manager abuses which states that if your manager is abusing his authority, there might be instances of window dressing, turnover and churning. This results in selling losers prior to quarter end, excessive replacement and unnecessary trading in order to fix the books.