Mutual funds pool the assets of multiple investors, providing buying power
that exceeds that of all but the wealthiest individuals.
Suppose you have $10,000 to invest. If you try to spread the money
around into 50 stocks, commission costs alone might cripple you. But invest
that same $10,000 in a mutual fund that owns 50 stocks, and you’ve
purchased a tiny piece of each of those companies without the expense or
hassle of acquiring them individually.
Professional money managers decide when the fund buys and sells, and
all of the investors win or lose together. If a mutual fund returns 10% in a
year, every investor who owned the fund at the start of that year will see the
same 10% return on his investment.
At the end of 2012, investors worldwide had $26.8 trillion invested in
mutual funds, with $13.0 trillion of those funds in the hands of U.S. money
managers, according to the Investment Company Institute (ICI). Of that $13
trillion invested in U.S. mutual funds, 45% was in stock funds and 26% was
in bond funds.
Stock and bond mutual funds come in two flavors:
Passively managed funds. Often called index funds, passively
managed funds attempt to match the performance of an index. Indexes
—such as the well-known S&P 500 Index of large-company stocks—are
baskets of securities constructed to approximate the investment
returns of a slice of the financial markets. Most indexes don’t change
their component stocks often.
Actively managed funds. Unlike passively managed funds, actively
managed funds buy and sell securities in an effort to exceed the return
of their benchmark—usually an index or group of indexes.
It’s tough to overstate the importance of mutual funds as an investment
vehicle. In the United States alone, more than 92 million people own mutual
funds, often through retirement plans. Additionally, most 401(k) retirement
plans invest workers’ assets in mutual funds, so if you participate in a
company-sponsored retirement plan, you probably already own funds.
Professional management. Most individuals don’t know much
about analyzing investments because of a lack of interest, a lack of
training, or both. When you purchase a mutual fund, you’re hiring
an expert to manage your money.
Choice. With nearly 9,000 traditional mutual funds on the market,
just about any investor can find a fund to address her investment
Diversification. Portfolios containing a variety of stocks or bonds
tend to be less volatile than an individual stock or bond. Mutualfund managers use their buying power to purchase multiple
securities, which in most cases provide diversification.
Costs. Every mutual fund charges fees. If a broker tells you his fund
doesn’t charge a fee, hang up the phone immediately because he’s
lying. Remember that expert you hired when you purchased the
mutual fund? He doesn’t work for free. In addition, some funds
charge fees called loads, collecting extra money to compensate the
salesperson or investment company.
Complacency. Mutual-fund investors often assume that since they
have a professional managing a diversified basket of stocks, they
can sit back and relax. Don’t make that mistake.
Poor returns. Last year, only about a third of actively managed
mutual funds outperformed their benchmarks. Plenty of academic
studies suggest this trend isn’t new and that fund fees deserve much
of the blame. While the chronic underperformance shouldn’t scare
you away from mutual funds, it should hammer home the
importance of choosing your funds wisely.
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