Advanced Diploma of Financial Planning (ADFP) Practice Test

What type of fund is characterized by low costs and broad diversification?

1. Hedge funds

2. Exchange-traded funds

3. Mutual funds

4. Unit investment trusts

The correct answer is: Mutual funds

The correct choice, which is mutual funds, is characterized by pooling money from numerous investors to invest in a diversified portfolio of stocks, bonds, or other securities. This structure allows for broad diversification because a mutual fund typically holds a variety of assets, which reduces the overall risk for investors. Additionally, mutual funds usually come with lower management fees compared to actively managed funds, contributing to lower overall costs. Hedge funds, while often diversified, typically have higher fees and are less accessible to average investors, focusing on sophisticated strategies and requiring a higher minimum investment. Exchange-traded funds (ETFs) also provide low costs and diversification, but they trade on exchanges like stocks, which can lead to different trading dynamics compared to mutual funds. Unit investment trusts (UITs) are less flexible and often have higher associated costs and less active management, which may not offer the same level of diversification as mutual funds.