Too much or too little diversification. This is more or less about perspective. Diversification can be viewed as an advantage when compared to dumping all your money into one stock. Some funds are focused on a specific industry or sector, so there’s not enough diversification. If you’re 100% invested in the oil industry, you’re not doing so well right now. Likewise, too much diversification can hurt because of dilution. If a particular security does extremely well, it would not impact the fund too much. Likewise, if a security tanks, it shouldn’t hurt too much either. By owning a large number (usually 50-150, but there can be many more) of investments, mutual funds do neither remarkably poorly nor remarkably well.
Costs. Do you really get what you pay for? Professional management is the backbone of mutual fund investing, with investors willing to fork over more money for better management. Mutual funds have two types of fees: annual fund operating fees and shareholder fees. The annual fund operating fees are between 1-3% per year and the shareholder fees are (loads and redemption fees) are paid by shareholders when they buy or sell funds. With individual stock investments, you only pay a commission when you buy and sell.
Cash. I wrote a previous blog about how mutual funds cannot quickly switch their investments to cash to protect their investors – this isn’t what I’m talking about. Mutual funds have to keep a large part of their portfolio as cash for withdrawals. This is cash that’s not working for the investor.
Size rules. Let’s say your mutual fund focuses on small companies. However, because there are rules about how much of a company a fund can own, you’re at a disadvantage. If a mutual fund has $10 billion to invest and can only invest an average of $100 million in each company, the fund might be forced to lower its standards. This also means if the mutual fund finds a great company, they can’t make large bets (this is about perspective too).