I've had a number of questions about investing in Mutual Funds. It is the "vehicle" that most companies offer you as you set money aside in your 401(k). The concept of Mutual Fund is not hard but selecting the mutual fund that suits you is a little more difficult.
The most fun is selecting one stock, watching it grow, collecting your profit and dancing into the sunset. Unfortunately not all stock goes up and sometimes one announcement can cause a major change in stock value. Merck voluntarily withdrew it's blockbuster drug Vioxx from the market because of alleged heart problems. When it made the announcement everyone was concerned about lawsuits and the stock fell 25% within 8 hours. Bummer. Most people don't want to take that kind of a hit, especially in their retirement account.
So some financial genius decided to select a "breadbasket" of various stock, put them together in a single Mutual Fund and then make them available to you. When you buy a mutual fund you are buying various stock under one umbrella. At the end of the day, the mutual fund adds up the results of how all it's stock selections did and publishes in the paper, a NAV (net asset value). You can look in the paper everyday and read how your particular fund did. I think there are now more mutual funds available than the number of individual stocks in the New York Stock Exchange and NASDAQ combined.
In most cases, mutual fund are good things. They diversify risk by buying many different shares of stock so if one goes down, the rest buoy it up and you don't take a big loss. You get full time professional management of the fund including research. You can invest through automatic payroll deduction and all your dividends in the fund along with gains and losses in sale of stock within the mutual fund get reinvested by the manager.
Now the sleezy side of mutual funds. Some funds charge as much as an 8% fee for you to get into. So if you invest $1,000, the management gets $80 just for taking the money into their fund. Now you have $920 to invested. You need to gain 8.7% just to get back to $1,000. That is baloney because you can find excellent funds that do not charge any commission. Usually life insurance salespeople offer mutual funds as the investment vehicle within a "whole life policy". You are getting screwed royally. Mutual funds can charge you getting in, charge you with reinvestment fees while you are in the fund and charge you to get out. They can charge redemption fees, exchange fees, and management fees. A key to getting rich. Avoid all the un-cessary fees.
Now the good news. There are fund families out there that charge nothing to get in, nothing to get out and a annual management fee (which is fair to watch your money) of less than 0.5% (one half of one percent). Vanguard and Fidelity are excellent mutual fund groups.
Your employer usually offers a menu of mutual funds typically selecting a Vanguard or Fidelity family of funds for you to chose from. The Employer should have your best interest at heart and paying big mutual fund management fees is not in your best interest.
I do not have enough space in this blog to begin to talk about the techniques you should use in choosing a particular fund. I'll attempt that another time.
If you remember nothing else: Mutual Funds diversify your risk in investing in stocks making them a good thing AND mutual funds that charge all kinds of fees other than an annual management fee are bad.
Some mutual funds will say that they are so astute at picking stock that they are worth additional management fees. There are very, very, very few that can back up that claim over the long term. Don't participate in that kind of fund.
If you have questions, let me know.
Love,
Dad (Just Chas.)