Happy March! In January, I started a “down and dirty” educational series on the basics of investing. In January we examined stocks and spent some time on bonds in the February issue. This month we’re ready to fit the pieces into place and talk about mutual funds which are probably the bedrock of what most of you call your “investments”. As I noted in the last two issues, if you have a degree in finance, this article isn’t for you. But if you want someone to explain “mutual funds” in plain English, you’ve come to the right place.

As an investor, you need to recognize that there are 3 kinds of financial assets that are easily turned into cash: stocks, bonds, and cash. When I say “cash”, that can include checking accounts, savings accounts, certificates of deposit (C.D.s), and money-market accounts. The best way to think about a mutual fund is that it’s a “basket”: it can hold stocks, bonds, cash, or any combination of these. In the U.S., there are over 10,000 mutual funds. The biggest benefit of a mutual fund is that they provide diversification, meaning they can help you address investment risk by not “putting all your eggs in one basket”.
Depending on the particulars of the mutual fund, you can start investing in stocks or bonds at a much lower “all-in” minimum level than if you were to buy shares of an individual stock or an individual bond. For instance, there are mutual funds out there that allow you to start with a minimum investment of only $ 250.00. One share of some big-name stocks out there can set you back over $ 1,000.00! The beauty of diversification comes in when you consider that most mutual funds own hundreds or thousands of different financial instruments like stocks and/or bonds and you can buy a small slice of all
of those with a small minimum investment. The thought is that if something goes down, there’s a chance something else in the fund could go up. Instead of having to choose between one medical device company or another, you could buy a whole host of individual stocks in that sector!

Because there are so many to choose from, deciding to invest in a particular mutual fund can feel overwhelming. Working with a professional advisor can help as you are paying for that professional to help guide you, but you should arm yourself with a little knowledge about the different types of funds. Mutual funds can be divided into those that have a “load” and those that are referred to as “no-load”. The “load” is the fee you as an investor pay, separate from a management fee, to buy into that particular fund. Loads can be either charged at the time of purchase (front-end loads) or at the point where you sell the fund (back-end loads). Just because a mutual fund has a load does not make it a “bad” fund or a poor investment choice. Rates of return over time, the fund’s expense ratio (we’ll get to this in a minute), and any other fees your advisor proposes to charge you will all need to enter into your decision as to whether a particular fund is “expensive” or a good value. You also need to look at a mutual fund’s expense ratio which is the annual fee on the amount you have invested that comes off
the top of your investment every year. The expense ratio pays the fund manager(s), pays for shareholder correspondence, keeps the lights on at the investment company’s place of business, and all the other assorted costs that go along with management of a mutual fund. Of all the mutual funds out there, the average expense ratio is 1.00%-1.25%. Funds which can be classified as “passively-managed funds” are less expensive to run than “actively-managed funds” and thereby have a lower expense ratio.

A passively-managed fund is also known as an “index fund” and the assets it contains mirror a set pool of investments like all the stock in the Dow Jones Industrial Average or all the stocks in the Standard & Poor’s top 500 companies. These funds buy a particular asset and merely hold it until the index in question makes a change, which happens very rarely. There is no active buying, selling and decision-making on the part of the managers, so the costs are less. The investment managers for actively-
managed funds do research, travel to individual companies to meet with CEOs, and engage in other costly behaviors in an effort to deliver superior returns to their mutual fund holders. These funds, then, have a higher expense ratio. Some years, actively-managed funds do better and, other years, passively- managed ones do. Again, a thorough analysis of long-term trends in overall returns and total “all-in” costs will guide you in your decision-making. Asking your financial professional to run a Morningstar report of a suggested mutual fund will clearly show long-term investment results, loads, expense ratios, and any other fees. Be sure to factor in any fee that your financial advisor may charge you for his or her advice.

A single mutual fund provides diversification in its holdings, but make sure you also diversify with a variety of mutual funds in different spheres like different sizes of U.S. company stocks, different types of bonds, and perhaps a dose of some foreign holdings if that is appropriate for your particular situation. Stocks and bonds move differently and U.S. and foreign assets move differently, so spreading your risk in several different ways may serve you well. A financial professional has been trained to analyze your particular situation and make suggestions that are best suited to you. Be sure to ask your advisor if he
or she is a fiduciary, someone who is held to the standard of always acting in your best interest above their own.

I would love to talk mutual funds with you! Call me anytime at 563-949-4705 or email me at heidi@hhcinvestmetns.net.