Uncommon Cents

Since I got so much nice feedback on yesterday’s post on what an index is, I thought we’d once again take a trip backwards, this time on Christmas Eve (insert “It’s a Wonderful Life” jokes here), let’s discuss what a mutual fund is.

A mutual fund is a form of investment that takes money from many investors and invests it in some type (or types) of securities (such as bonds and stocks). It is managed by a professional fund manager. Think of your mutual fund shares like your plate at a Christmas pot luck–by yourself, you may have only been able to get a single dish, but with the help of all of the others at the party, you can have a little of dozens of dishes.

Beyond that, there’s lots of variation in mutual funds. A mutual fund may be actively managed (meaning that the securities in them are traded frequently) or passively managed (meaning that the securities in them are virtually never traded); it can also follow an index or a certain sector of securities; it can have a load (a sales charge) or not; and it can have high expenses or not. There are so many mutual funds that it’s impossible to discuss them all, so let’s just look at some generalities.

One of the big advantages of mutual funds is that they bring more purchasing power to the small investor. If I want to own every stock in the Standard & Poors 500 index, it would be unfeasible (if not impossible) for me to do so as individual stocks; however, if I purchase a mutual fund that follows the S&P 500 (like the Vanguard 500 Index Fund), I can, with the convenience and economy of one single fund purchase, have performance that is essentially equal to the S&P 500 without having to purchase 500 or so individual stocks on my own. This means I get the risk reduction of diversification with only one transaction, saving me time, money, and the headache of investing in each company individually. All I have to do is go to my discount broker or directly to the fund family, lay down my money, and tell them I’d like to purchase as many shares of their no load S&P 500 index fund as I can.

It’s also possible to choose funds for almost every possible market sector or interest. If I want a fund that tracks the performance of the total stock market, I can do that. If I want a fund that does the same but with bonds, I can do that. International stocks? No problem. If I want a fund that seeks dividend payouts or follows energy stocks or is socially aware, I can do all of those too. Or if I want a fund that seeks out growth stocks or value stocks or large cap or small cap or even a “fund of funds” (a single fund that is made up of several, say a domestic stock fund, a domestic bond fund, and an international stock fund)… there’s a fund for just about everyone and every niche.

In my opinion, the best of the mutual funds are the no load index funds, which feature index matching performance, extremely low expenses, and unmatched diversification. The vast majority of the money I have invested is invested in two index funds–the Vanguard Total Stock Market Index Fund and the Vanguard Total Bond Market Index Fund–and the majority of the remainder would be in a third–the Vanguard Total International Stock Market Index Fund–were it an option in my 403(b) plan. And before I sound like a Vanguard shill–I’m just a satisfied customer–there are alternatives, such as Fidelity and T. Rowe Price.

So go ahead and indulge your investing appetite with a steady diet of mutual funds, particularly low cost, no load index funds–although you will certainly have a huge variety to choose from. While they may seem boring to some, just remember that owning a mutual fund of the no load, indexing variety is a lot like being at a pot luck–a little of everything tends to be a lot more fun than a lot of a single thing. And in this case, a little of everything will help to make your life a wonderful one too.

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