Hedge Funds vs. Mutual Funds: Decoding the Differences

As you begin dipping your toes into investing, you’ll hear about various options. Many financial experts agree that a diverse portfolio with multiple risk types, such as mutual and hedge funds, is the most effective way to ensure long-term growth. But if you’re unsure of these investment strategies, you’re understandably hesitant about putting your money into them.

While some people use hedge and mutual funds interchangeably, the reality is that the two investments are distinctly different. They’re both part of a managed portfolio, but that’s where the similarities stop. 

Having a financial advisor can help you make informed decisions about your portfolio, but it’s also wise to educate yourself on your investments. Here, we’ll explain the differences between hedge and mutual funds to ensure you choose the right strategy for your goals.

Introducing Hedge Funds and Mutual Funds

Before we discuss each of these options in detail, let’s briefly introduce hedge and mutual funds.

Mutual funds are a lower-risk, regulated investment with restrictions on what types of opportunities can be traded. In a mutual fund, the manager uses defined strategies to attain and pass a benchmark index to profit from flat fees.

A hedge fund focuses on those with high net worth willing to take on more risk for greater return. Your investment is given to a financial expert who uses multiple diverse higher-risk/higher-return trading strategies to bring you a profit. Rather than flat rates, hedge fund managers charge management and performance fees.

The Details On Mutual Funds

Mutual funds are accumulated by using pooled money from every investor. These investments can start at as little as one dollar and are regulated by the US Securities and Exchange Commission (SEC). Mutual funds can be traded as long as the stock market is open. You or your trader can buy and hold securities using your agreed-upon strategy.

Because of the low investment threshold, mutual funds are an accessible entry point for beginning investors. Through shared money, you can gain access to publicly traded securities by buying shares of a mutual fund. Your fund manager pools your money with others like you, who use strategies to attain the objectives agreed upon in a prospectus.

More About Hedge Funds

On the other extreme are hedge funds. These accumulate by using pooled money from investors who have been accredited and have either an annual income of $200,000 or more or a liquid net worth exceeding $1 million. These are popular with busy professionals like physicians, who work with specialists like OJM Group to manage their investments.

Hedge funds permit more flexibility for the investor. They’re regulated by the SEC but not as heavily as mutual funds. However, there’s a limited window in which you can invest or withdraw your funds throughout the year.

Your investment trader will use strategies like shorting, derivatives, and alternative buying of assets to boost your profit. In exchange, they’ll charge you fees based on their performance and the types of assets under their management (AUM).

Which Strategy Should You Use?

While mutual funds are often the first choice for a beginning investor, they may not give you the higher return you’re looking for. So, which investment strategy is right for you?

Generally, a mutual fund is suitable for those looking for a safer investment for lower dollar amounts with set fees paid to the fund manager. Mutual funds are a good option if you’re risk-averse or don’t have a high-income threshold for hedge funds. They can be actively or passively managed and often require no minimum investment, making them ideal for all investor levels.

Hedge funds are best for those with more money to invest and less risk aversion. These are designed to give individual investors access to more complex yet volatile strategies that they believe will provide a higher return. With more strategies, less regulation, and better opportunities to gain leverage, investors in hedge funds can gain — or lose — more money. However, hedge funds may have a minimum investment of $1 million or more through limited investment windows.

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Conclusion

As you read the summary of hedge funds and mutual funds, you were likely attracted to one over the other. The next step is to reach out to a financial expert who can guide you step-by-step on making your first investment and starting the path toward passive income building through a diverse portfolio.