Mutual: of or relating to each of two or more; held in common; shared.
Funds: a supply of money, as for some purpose.
These words get lumped together very often. And to many people they may represent some sort of substitute to “investing” or “money”. But what the heck are mutual funds? What can they actually do? And where did they come from?
What is a mutual fund actually trying to accomplish? A mutual fund’s main objective is to invest in multiple things with one investment. Instead of buying one stock or one bond, with a mutual fund you can use the same amount of money to buy a mutual fund that holds many different stocks or bonds.
The very first mutual fund in America is actually still around. There were many similar products and investments before the first “mutual fund”, but in 1924 the Massachusetts Investors Trust was created. MFS is still a highly respected company in the investment world to this day.
When you go to buy a mutual fund either in your retirement account, with a broker dealer, or an online platform, there are usually minimum amounts needed to invest. But once you’ve met that minimum you can invest however much you want (even half or partial shares). Mutual funds allow investors to continuously invest into them and to redeem shares instead of having to sell them in the open market. A mutual fund is actually called an “open ended” fund because it is always open to new investments.
So when you buy into a mutual fund you’re buying teeny tiny portions of all the things that the mutual fund actually owns. If the mutual fund has $100K total and $50K of that is invested in Apple’s stock, 50% of the mutual fund is Apple stock. So if you own $1,000 of that mutual fund, you theoretically own $500 of Apple stock.
Mutual funds are great tools to be able to diversify. Instead of using your $1,000 to buy Apple stock, with a mutual fund you can use your $1,000 to buy 100 different stocks or even more.
Now, there is a rift in the fund universe right now. The argument between active and passive management. Active management of a mutual fund means that a person or group of people actively seeks to buy and sell the stocks or bonds in a mutual fund to try and beat the market. But a passive strategy seeks to exactly replicate an index such as the Dow Jones Industrial or the S&P 500.
There are positives and negatives to both that I will address in a future post, but the main thing to identify is that both are better than buying just one stock or just one bond.
There is a huge risk in just buying one stock or one bond. Let’s say that we just bought Apple stock and the next day the stock market is doing okay, but Apple announces that they lost all the iPhone 8’s in the ocean because of a huge hurricane. Apple’s stock would go down by a lot, while the rest of the market would remain pretty normal.
The benefit of a mutual fund, whether it is passively or actively managed is that you could still own a portion of Apple in the fund, but the other stocks or bonds in there would keep your money from totally disappearing.
So obviously the last thing we have to talk about is the cost of buying a mutual fund. This is somewhat complex and is usually meant to be a little confusing to the investor. I could spend a whole post trying to describe how mutual fund companies make money. But the main thing to think about is that mutual funds, both passive and active, charge a fee to manage your money.
Some mutual funds charge you a “sales charge” up front to cover the cost of the sales person who you might have worked with; others charge you a “sales charge” when you sell out of it, if you have not held it long enough. Most passively managed funds are way less expensive than actively managed funds, because the managers don’t have to work as hard to find investments for the fund cause they are just trying to match the index exactly.
A mutual fund is a great way to diversify your money and spread your small or large investment over a wider group of stocks or bonds. These benefits should not be lost when trying to figure out which type of fund to buy or how much it costs, because in the end you are better protected than if you just bought a single stock. Hopefully you will be able to understand these investment tools whether just investing personally or investing for your retirement.