Question

One disadvantage of investing through mutual funds is

A. that they provide time savings.

B. that there are more than 8,100 to choose from.

C. the professional management.

D. too much diversification.

Answer 1

The correct answer is D. too much diversification.

Diversification reduces risk for the investor. However in case of mutual fund diversification is good but too much diversification can be harmful. Too much diversification means adding different securities in the portfolio. As the number of securities increase the fund manager has to allot additional time and resources in managing the fund. This will increase the operating cost of the mutual fund. As mutual funds are managed by professionals they will find it difficult to manage the over diversified portfolio. This will lead to fall in returns from the mutual fund as management of the fund is very important to achieve desired results.