When you’re making decisions about the future of your finances, you might want to get familiar with the hedge fund vs. mutual fund difference. While they may seem similar, there are some significant disparities that impact which option will suit you better.
In this post, we’ll discuss investment vehicles and how they work. Let’s begin!
What Is a Hedge Fund and What Is a Mutual Fund?
A hedge fund pools capital from accredited investors for investing in various assets, often via complex execution strategies.
Hedge funds are typically only available to wealthy investors because they come with high minimum requirements and needn’t be registered with the SEC.
A mutual fund is also an investment vehicle comprising a pool of money from many different investors. However, unlike hedge funds, mutual funds are accessible to all investors and regulated by the SEC.
How Hedge Funds and Mutual Funds Differ
When it comes to hedge funds vs. mutual funds, there are several key differences to be aware of:
|Mutual funds||Hedge funds|
|Pool money from||Public investors||Accredited investors|
|Regulations||SEC Regulated||Not regulated by the SEC|
|Fees||Management fee (1–2%)||Management fee (2%) and performance fee (10%–30%)|
|Holding period||Several years||Depends on the fund strategy (from days to years)|
|Trading options||Stocks and bonds||Stocks, land, real estate, bitcoin, public securities, life insurance, lottery tickets|
Now that you know the key difference between a hedge fund and mutual funds, let’s get into more detail.
When it comes to investment strategies, hedge funds are typically more aggressive than mutual funds. Hedge fund managers often use complex strategies, such as convertible arbitrage, to try to generate higher returns.
While these strategies are quite lucrative when they succeed, they also come with a higher risk of losses.
On the other hand, mutual fund managers take a more conservative approach. They may use some of the same strategies as hedge funds, but are usually less aggressive. This means that mutual funds tend to have lower returns than hedge funds but also come with a lower risk of losses.
The central hedge funds versus mutual funds difference is that the latter is open to the general public. In contrast, the former is available only to accredited investors (individuals with a gross income higher than $200,000 or net worth higher than $1 million).
Moreover, the minimum investment required to start a hedge fund is also rather high. For example, mutual funds require a minimum deposit between $500 and $5,000. For hedge funds, you’ll have to set aside from $100,000 to $2 million.
This means hedge fund investors are typically wealthy individuals, insurance companies, and foundations.
Another mutual fund vs. hedge fund difference is that the latter has a lot of freedom regarding what you can trade.
With hedge funds, you can buy and sell anything, such as equities and derivatives, cryptocurrencies, real estate, life insurance, public securities, and even lottery tickets.
Mutual funds, on the other hand, can only invest in publicly traded equities, such as stocks and bonds.
Next in our mutual funds vs. hedge funds comparison, we’ll discuss the fees. Hedge funds are generally more expensive to be a part of than mutual funds. Hedge fund managers don’t just charge a management fee (2%), but also a performance fee (from 10% to 30%).
This implies that the better the fund’s performance, the more you’ll have to pay as an investor.
Conversely, the typical management fee for mutual funds amounts to 1–2%.
Another noticeable difference between a mutual fund and a hedge fund is the regulation. Namely, hedge funds are not required to register with the SEC.
This lack of regulation gives hedge fund managers a lot of flexibility in their operations. However, that also means greater risk for investors.
That said, mutual funds must register with the SEC and disclose a lot of information about their operations.
While this increased regulation protects investors, it also limits the flexibility of mutual fund managers.
Hedge vs. Mutual Fund Investing Benefits
Let’s take a look at the advantages of each type of investment:
Hedge fund benefits:
- The potential for higher returns
- Not regulated by the SEC, so managers have more operating flexibility
- Wide range of investment strategies
Mutual fund benefits:
- Low risk and volatility
- Subject to strict regulations which protect investors
- Managers have a limited range of investment strategies available, reducing the chances of bad investment decisions.
So, is there a winner in this mutual vs. hedge fund competition? No, because it all depends on your investment goals. If you’re looking for higher returns, hedge funds may be the way to go, but you’ll have to jump through many hoops to qualify.
If you’re more interested in preserving your capital, mutual funds could be a better fit. It all comes down to what you’re hoping to achieve with your investments.
Is it good to invest in a hedge fund?
Yes, but only if you are an accredited investor who’s willing to take on more risk in exchange for the potential for higher returns.
On the other hand, even if you do meet the requirements, you should avoid investing in a hedge fund if you’re not comfortable with the higher risks.
Do hedge funds outperform mutual funds?
There is no definitive answer to this question, as the performance of both types of funds can vary greatly in any given year. However, over the long term, hedge funds tend to underperform mutual funds.
The main reasons hedge funds underperform are:
- Unequal distribution
- High fees
- Poor investment decisions
- Increasing fund size
- The expansion of the hedge fund industry.
Are hedge funds better than mutual funds?
Hedge funds are a better option for people looking for higher returns and willing to take on more risk. On the other hand, mutual funds may be a better choice if you’re looking to protect your capital and are more risk-averse.
In other words, the winner in this hedge fund vs. mutual fund battle will depend on your investment goals.