Once investors have decided on the appropriate asset allocation for their portfolio, they must decide on the best way to implement the plan. Investors have the choice of buying individual securities, mutual funds, or exchange-traded funds (ETFs). Mutual funds and ETFs often provide benefits over individual holdings, though those benefits may not exceed their associated expenses. The right answer will depend on a variety of issues unique to each investor or unique to the asset class to which the investor seeks exposure. We will examine the issue by looking at the benefits of each strategy, beginning with convenience.
Unless the mutual fund is a load fund (which should be avoided because they add expenses without adding value) investors can buy and sell shares at the net asset value (NAV), where there is no bid-offer spread, and buying and selling is done at the same price. When the transaction is made directly with the fund sponsor it can generally be done without incurring any transactions costs. It also allows for the ease of reinvestment of dividends, distributions, and interest.
Another benefit of investing through mutual funds is the ability to trade relatively small amounts ($5,000 or $10,000) in order to generate cash for spending or in the portfolio rebalancing process. This may be especially important for bonds.
The most important benefit of mutual funds is allowing investors to achieve broad diversification ...