Do you feel stupid when you’re with a group of “friends” who are talking about their “portfolio’s” and investment strategies, including mutual funds? Do you smile and nod your head, much like you’d do if you were in a foreign country trying to communicate with the locals? If asked your opinion about a stock, do you simply say, “Oh- I let my advisor handle that”, when the closest thing you have to a financial advisor is your favorite bank teller? No matter what you may hear, you need to remember that you’re not alone. Congratulations on taking the first step to understanding the complicated world of investments, beginning with Mutual Funds.
Square One – The Absolute Basics
A Mutual Fund is a “medium place” for investors, enabling many individuals to pool their money together with one common goal- to make money. Instead of each of these individual investors trying to pick stocks and bonds out of thin air, they combine their money and buy a Mutual Fund. It’s kind of like a bunch of people being “roomies” in the fund- as maybe they cannot afford to “invest/live” out on their own, so they all live together to cut the expenses. Or maybe they just don’t like to “invest/live” alone, and feel more comfortable in a group.
The fund itself has a “Fund Manager” who is responsible for investing the pooled money into various securities like stocks and bonds. Each individual investor becomes a shareholder of this one particular fund.
Square Two- “Diversify”
You’ve probably heard the term “diversify” a lot in your circle of “investing friends”. Simply put, this just means “Don’t put all of your eggs in one basket”- as if you drop the one basket, all of your eggs are broken/useless. If you split up your eggs into more than one basket, you’ll have a much better chance of reaping the benefits of your unbroken eggs, even if one of the baskets falls. Of course, you’ll want to be sure that a quality company is carrying your baskets.
If you were to head out and diversify your portfolio (your personal grouping of your investments) on your own, you would have to buy all types of different stocks (shares of companies), then dabbling in bonds (lending money to the government and companies), then hitting the international market, and so on. This would take weeks, to say the least. Mutual Funds allow you to do the same thing in much less time- and we all know that time equals money.
Square Three- The Types of Mutual Funds
This is where things can get a bit tricky, so a good financial planner (preferably one that is NOT commission based (you want them to be completely truthful and unbiased when it comes to your money). The types of Mutual Funds are named for their particular category- like low-grade corporate bonds, international small companies fund, etc. And they all yield a different rate of return (depending on the risk factor) as well as a risk of losing money. Think of it like a horserace—if “Small Company Fund” has odds of 50 to 1 to win, he’s going to pay off much better than “Low-Grade Corporate” who has won the past 10 races. While either could lose (or win) the odds are in the favor of the better performer.
