When it comes to investing, knowledge is power. To make the most of their participation in the stock market, all investors should have at least a rudimentary understanding of the types of investment options available and how these options can help grow their assets. Hedge funds and mutual funds are two examples. Although often confused with one another, these funds are distinct vehicles designed to interact with the stock market in unique ways.
How Are These Funds Similar?
Hedge funds and mutual funds are similar in that they are both financial portfolios, meaning they represent a collection of investments that must be tracked and managed. They are also both used for making profit. Beyond this, however, is a world of difference. Which fund investors choose to use depends on their objectives and vulnerability to financial risk.
Hedge Fund vs Mutual Fund: 5 Differences
The differences between hedge and mutual funds are outlined by James P. Owen. Here are a few of his points:
Mutual funds generally cater to a broader audience made up of both small and large investors. The required capital necessary to invest is small, often only around $2,000. Hedge funds, on the other hand, require a substantial amount of money. Some can demand as much as $5 million in an account before participation.
In mutual funds, managers are required to adhere to the types of strategies described by the fund when it was first established. Their success is determined by the direction of the market. Thus, the securities they invest in tend to be relatively safe. Hedge funds, on the other hand, are far more aggressive in nature. Managers of hedge funds have more freedom in their investment choices; whether or not a fund succeeds strongly depends on the expertise of those individuals. Hedge funds take the approach of managing rather than avoiding risk, so they are generally more opportunistic in nature.
Mutual funds have more modest goals than hedge funds. The aim is simple: to make a return that is higher than the original investment. In contrast, the goal of a hedge fund is to deliver absolute returns by attempting to make profits in any and all circumstances. This is why the performance of hedge funds has a low correlation to the performance of the market; in the case of mutual funds, the opposite is true.
While both types of funds charge fees, the amounts and structures differ dramatically. Mutual funds have limits to the amount of fees they can charge, and all investor documents must contain them in a prominent place. Hedge funds have no limits to the number of fees they are able to charge and usually require them based on both fund assets and performance.
The regulations for mutual funds are far more stringent than those of hedge funds. The Securities and Exchange Commission (SEC) requires mutual fund companies to register with the government before they even begin to work with the public on any investment activities. Furthermore, mutual funds are subject to numerous regulatory bodies and must comply with tax rules set forth by the IRS. Hedge funds, in contrast, are not required to be registered with the SEC and are under the supervision of fewer regulatory bodies.
Other Differences of Note
Hedgeable explains a few additional points of difference:
Performance: Because hedge funds rely on more aggressive techniques, they are more likely to outperform mutual funds in “Bear Markets,” or a condition defined by the continued downward spiral of the stock market.
Liquidity: Mutual funds can be bought and sold daily, without much hassle. Hedge funds have “lockup periods” where investor withdrawal is restricted for the first year or two, and then quarterly or even yearly afterwards.
Marketing: Hedge funds cannot advertise to the public. Mutual funds can.
When investors fully comprehend the features and restrictions of these funds, they are better able to make choices that will positively impact their wealth.
A Financial Education
Informed decision making is a crucial skill in the field of business. For individuals interested in preparing for success in this growing field, earning an online business management degree or an online MBA degree from Point Park University is an excellent way to start. Both programs are designed with students’ futures in mind, offering curricula immediately applicable to the real world.