If you're new to the world of investing or trying to navigate the many different investment vehicles out there you may be wondering what the differences are between a hedge fund vs mutual fund.
But don’t worry, personal finance is a big topic and investing can be awfully daunting to those unfamiliar with all the terms and lingo.
Fortunately, nothing is particularly difficult to understand so long as you have the right information. And, when it comes to investing, hedge funds and mutual funds are both extremely popular options that you'll certainly want to look into. Here's what you need to know.
Hedge Funds vs Mutual Funds: How They're Similar
Mutual and hedge funds are both types of managed portfolios, each being built using pooled funds and each having the same goal of achieving returns by diversifying investments. Since funds are pooled together, these funds have a dedicated manager, or group of managers, that use the investment capital from multiple investors in order to strategize.
Hedge Funds vs Mutual Funds: How They Differ
While hedge funds and mutual funds take a similar approach when you look at the big picture, there are distinct differences. For instance, you'll find mutual funds from institutional fund managers. They'll have many options available for both institutional and retail investors.On the other hand, hedge funds specifically target high-net worth investors. To invest in a hedge fund, you'll have to meet a number of characteristics associated with being an accredited investor such as a (usually rather large) minimum investment.
Comparing The Two
Here are some quick side-by-side comparisons to help you compare hedge funds vs mutual funds;
- Mutual funds are a type of regulated investment product.
- Mutual funds are offered to the public and they're available for daily trading.
- Hedge funds are a type of private investment only open to accredited investors.
Hedge funds generally use higher risk trading strategies with the hope of higher returns.
Active and Passive Funds
Mutual funds are nothing new in the world of investing. As of 2017, some numbers state as many as 7,956 mutual funds exist on the market, totaling over $18.75 trillion in assets.
The first one was actually created in 1924 by MFS Investment Management and, ever since, they have continued to evolve in a way that gives investors a number of opportunities for both active and passive managed investments.
If you choose a passive mutual fund, you'll be gaining the opportunity to put your money into an index that targets its market exposure at a small cost. On the other hand, active funds offer professional portfolio fund management.
Open-Ended and Closed-Ended Funds
As with other forms of investments, mutual funds are regulated. In the United States, the SEC (Securities and Exchange Commission) regulates them through two directives, both the Investment Company Act of 1940 and The Securities Act of 1933. The latter requires that investors are both educated and transparent.
Meanwhile, the former act lays down the foundation for structuring a mutual fund, and they can be either open-end or closed-end funds. Both of them trade daily, but an open-end fund has varying sales loads and fees. Open-end funds price daily at their net asset value (NAV) at the end of trading.
Closed-end funds, on the other hand, choose a fixed number of shares within an IPO, or Initial Public Offering. Similarly to stocks, closed-end funds trade throughout the date.
While mutual funds are a type of investment that any investor can get behind, some funds do have a minimum investment requirement. This can range from $250 up to $3,000 or even more. The minimum investment depends on the specific fund you're looking at. Hedge funds by comparison can have a minimum investment of several hundred thousands up to million dollar minimum investments.
In general, keep in mind that mutual funds are managed so that they can utilize a specific strategy to trade securities. The complexity of that strategy can vary largely, but most mutual funds do not rely heavily on alternative methods. By limiting such high-risk investments, mutual funds become more suitable for most investors out there.
Notable Fund Managers
If numbers mean anything, the largest mutual fund management companies include Vanguard (with total assets of $3.82 trillion), Fidelity (with total assets of $2.1 trillion), and Capital Research and Management (with total assets of $1.73 trillion).
Hedge Funds and Risk
Hedge funds generally take higher risks than mutual funds, all with the hopes of greater returns, and that means they often use tactics like short-selling, leverage, and options. As you can imagine, they're managed more aggressively in general when compared to mutual funds. They'll often take cyclical positions globally or try to achieve returns in falling markets.
At the end of the day, hedge funds are built on the same investment concepts as mutual funds, but hedge funds are still structured and regulated differently. As far as structure goes, hedge funds generally employ a tired partnership structure with a general partner and limited partners under them.
Since they offer themselves privately, hedge funds can only include accredited investors. The 1933 Act mandates this under Regulation D, and that's because accredited investors are generally regarded to have more advanced market knowledge and typically hold a higher risk tolerance.
With all of that said, the accredited investors who put money into mutual funds are willing to bypass the protections that mutual fund investors have for the sake of potentially making more for their money. Being private, hedge funds do enjoy a greater amount of flexibility when it comes to investor terms and provisions. That's why they also charge much higher fees than mutual funds do, and they also tend to be less liquid with varying redemption allowances and lock-up periods.
Hedge Fund vs Mutual Fund: Which One Is Right For You?
As you can see, mutual funds are the more accessible type of investment when compared to hedge funds. However, if you are an accredited investor and able to find a privately offered hedge fund, there are many good reasons to choose it over a mutual fund.
The best way to make your decision is to talk to a professional investment advisor who can help you choose the right investments for your goals.