This Article Contains:
- What is a mutual fund?
- Disadvantages of mutual funds
- Top five alternatives to mutual funds
Let’s get started.
What Is A Mutual Fund?
Mutual funds work by pooling investments from many investors to purchase a portfolio of traditional assets like stocks and bonds. Professional money managers then manage this fund to maximize returns for the investors.
Conventional mutual funds are an excellent option for a non-accredited, individual investor as they can access a portfolio of professionally managed securities without large investment minimums.
When investing in an actively managed mutual fund, investors typically earn returns in the form of dividends and price appreciation. These dividends come from the income the mutual fund generates.
Additionally, investors often have the option of reinvesting these earnings to create compounding returns.
3 Disadvantages Of Mutual Funds
While the traditional mutual fund is an attractive investment option, they come with their fair share of drawbacks:
1. There are tons of fees involved
Investing in mutual funds often comes with a list of fees, primarily because a money manager actively manages them. This means that the entity in charge of the fund needs to cover its own expenses before paying investors.
2. They can be illiquid
Mutual funds can be structured in one of two ways:
- The first way allows investors to cash out whenever they want.
- The other way requires investors to have their funds locked up for 5-7 years. While you’re still able to withdraw your money before the maturity date, you’ll have to pay an additional fee.
3. Risk of over-diversification
While diversification is one of the main advantages of mutual funds, there is the risk of over-diversification.
Diversification is effective at minimizing risk, but over-diversification can reduce your expected return rate.
The Top 5 Alternatives To Mutual Funds
While mutual funds have their advantages, they’re not the only investment option out there!
Here are five great alternatives to explore instead:
1. Exchange-Traded Funds (ETFs)
An exchange traded fund is an excellent option for focused investments such as targeting foreign currencies, energy, or commodities.
With an ETF, the fund provider owns the underlying assets, designs a fund to track the asset’s performance, and sells shares in that fund to investors - who earn in the form of dividends and price appreciation.
Investors are essentially shareholders in the fund but don’t own the underlying assets.
Several types of fixed income ETFs also pay investors a fixed income or dividend ratio until its maturity date. ETFs also tend to be a more liquid alternative fund - when compared to mutual funds.
Additionally, ETFs trade at any time (like stocks) while mutual funds are traded at the end-of-day price.
The beauty of ETFs is that they are a passive investment and aren’t actively managed by a fund manager. This reduces operational costs - resulting in you paying fewer fees.
The average expense ratio of an ETF is around 0.44%. The expense ratio measures the proportion of the fund’s assets used to cover operating expenses (the lower the expense ratio, the more you can earn).
While the expected return rate differs from ETF to ETF, they generally provide a steady income stream.
One of the better performing ETFs, the Invesco QQQ Trust, saw an average return of 48.4% in 2020, whereas one of the worst-performing, the S&P 500 Energy Sector, saw losses of 40% in the same year.
Tip: Public is an investment app that allows investors to invest in portions of stocks and ETFs at an affordable rate, with no minimum investment.
2. Hedge Funds
Hedge funds are a type of alternative fund and are very similar to mutual funds since they both pool money from many investors to invest in a diversified portfolio.
Hedge funds are also actively managed by fund managers who generally use options, short-selling, and other similar alternative investment strategies to generate returns for the investor.
Historically, hedge funds haven’t been aimed at everyday investors as they avoid traditional asset classes. Hedge funds are ideal for high-net-worth individuals since they require large investment minimums - much like private equity.
However, platforms like Titan, allow you to invest like hedge funds, with an investment as low as $100.
Hedge funds are usually riskier than mutual funds, but the potential for returns is also higher.
As far as fees go, most hedge funds use a "two-and-twenty fee," where there's usually a 2% annual management fee and a 20% performance-related fee (in other words, they keep 20% of the profits).
The hedge fund manager’s strategy determines the performance of the fund. As a result, potential returns can vary.
For example, from January 1994 to October 2018, the S&P 500 outperformed every major hedge fund strategy by about 2.28%. On the other hand, between 1994 and 2009, dedicated short strategies outperformed the S&P 500 on risk-adjusted returns.
3. High-yield Savings Account
A standard savings account isn’t going to help you grow your money exponentially. However, with a high-yield savings account, you can at least earn with higher rates of interest.
Most banks don’t charge you any fees.
However, these accounts usually come with some restrictions - such as only allowing a certain number of transactions a month.
If you’re looking to open a high-yield savings account, consider online banks - as they tend to offer better interest rates. American Express National Bank, for example, offers an APY (annual percentage yield) of 0.50% - as opposed to an average of 0.05% in regular savings accounts.
4. Index Funds
An Index fund is a type of alternative mutual fund.
While they may seem similar, they have several major differences.
The primary difference between an index fund and a mutual fund is their investment strategy.
Mutual funds are actively managed, and the fund is structured to match a specified investment objective outlined in the fund’s prospectus.
On the other hand, an index fund, is passively managed and therefore aims to match the performance of a financial index, such as the S&P 500. This typically results in lower fees but usually offers lower returns as well.
This gives index funds more predictability in terms of returns over time.
Many index funds have expense ratios (or annual fees) under 0.05%.
While the expected returns for index funds can vary significantly depending on the fund and the market, they usually offer moderate returns.
The S&P 500, for example, one of the most commonly followed indices, returned an average of 16.26% in 2020.
5. Alternative Investments
Alternative investments are a great way to break away from traditional investments, and they cover a wide range of asset classes with unique characteristics.
There are many reasons why investors gravitate toward alternative investment options, such as:
- They’re great for portfolio diversification.
- You can benefit from opportunities that aren’t available on a publicly listed market. Additionally, because they have a low correlation to the stock market, the investor stands to earn even in unfavorable market conditions.
- Historically, alternative investments have only been available to an accredited and institutional investor. But as technology develops, new platforms are emerging that allow everyday investors to capitalize on these asset classes.
Some alternative investments open to non-accredited investors include:
A. Real estate
Real estate investments are generally expensive, time-consuming and involve tons of due diligence. However, they do offer the potential for fantastic long-term earnings.
Luckily, you can now enjoy all the benefits of real estate investing for just a fraction of the cost and effort!
For example, Roofstock allows investors to benefit from investing in tenant-occupied rental properties.
The estimated capitalization rate for most properties on Roofstock is between 5% and 8%, with a gross return of 11% to 12%. The capitalization rate refers to the expected rate of return generated through real estate investments.
Art investments have traditionally been incredibly profitable - but reserved exclusively for the ultra-wealthy.
However, for investors who don’t have millions to invest in a piece of art, there’s Masterworks.
It’s a platform that lets anyone invest in blue-chip art by purchasing fractional ownership of famous works.
The minimum investment is $10,000 and investors earn by profiting from an increase in the item’s value once it’s sold. Masterworks has a targeted annual return of 8.9% - 12%.
While cryptocurrencies are an extremely risky asset class, they still have the potential to generate great returns.
And for investors looking to take advantage of crypto’s volatility, consider eToro.
It’s a cryptocurrency investment platform where investors can make the most of the crypto price swings by automatically copying the trades of professional crypto traders.
eToro has a minimum investment of $50 with no annual fees.
D. Sports memorabilia
Non traditional investments like high-end sports memorabilia are a relatively new investment class. As many of these items are so rare and valuable, they tend to be extremely expensive.
Fortunately, with Collectable, you don’t need to spend millions to own a piece of sports history.
You can purchase fractional ownership of the memorabilia and start earning once the asset sells or by trading through the secondary market.
While returns vary between items, in 2020, Collectable sold a Patrick Mahomes rookie card for $182,500, providing investors with a return of 35% in just one month.
The minimum investment varies based on the offering - some are as low as $5.
Investing in fine wines has shown steady returns, outperforming the S&P 500 and many alternative assets.
While wine investing is usually associated with large capital requirements, Vinovest has changed this.
For non-accredited wine lovers, Vinovest is an excellent opportunity to affordably diversify your portfolio.
Depending on the plan you opt for, Vinovest offers annualized returns of 12.4% in the Moderate Plan and 16.6% in the Aggressive Plan.
While mutual funds are still a great investment option, there are several alt funds out there.
However, with the number of different investment options available, choosing one that suits your needs can be challenging, so how do you find the best one?
Although a financial advisor is a good source of investment advice, it’s always worth doing your own research beforehand.
If you’re looking to compare investment platforms, MoneyMade has all the information you’ll ever need. With potential risks, returns, minimum investments, and more, MoneyMade is your go-to place for all investment-related queries!