How Mutual Funds Work
This has been a tough subject for me to get my arms around. I so badly want to
explain how mutual funds work—but to be honest, I was confused as to how to go
about doing it. I’ve learned that when I get too technical about mutual funds,
peoples’ eyes glaze over. Then, they lose interest. And, when that happens, they
deprive themselves of learning about what I believe is the average person’s
greatest investment tool. Mutual funds aren’t perfect investments. As a matter
of fact, I don’t know of a perfect investment. (No investment always has high
returns with low risks.) But, mutual funds often do allow the small investor to
enjoy many of the benefits that would otherwise only be available to the richest
investors.
Although they date back at least to the 1920’s, mutual funds have really hit
their stride in the last twenty years or so. As of 2000, the Investment Company
Institute says there were about 8200 mutual funds available to the public.
Different funds have different purposes and personalities. They invest in
different types of assets. The costs, fees, and expenses of various funds vary
widely—to say nothing of their performance. Add to this mix the fact that every
investor has different needs, goals, and risk tolerances. With all these factors
in mind, this could become a confusing chapter. But, you have my word that I
will try my best to keep it simple and clear. To accomplish that goal, please
understand that I will not be getting into the highly technical aspects of
mutual fund investing.
If you want to learn more, there are lots of great books and websites that will
help you do that. In this section I will be making broad assumptions and sharing
generalized concepts. Nothing is meant to be the final word, or exhaustive. As
with everything else in the No Debt No Sweat! system, please understand that is
your responsibility to get further and more complete information before you
invest. In addition to getting competent professional advice, I would encourage
you never to buy any mutual fund until you understand it. While mutual funds
offer many advantages, they have their trade-offs, too. Always read the
prospectus carefully, ask questions, and get satisfactory answers before you
invest.
Just the Facts, Ma’am
I always liked Dragnet. Joe Friday had a way of finding the bad guy by always
asking for “just the facts, ma’am.” I guess when you’ve got to solve a caper in
30 minutes (minus commercials), staying focused is important. So, let’s spend a
few minutes talking about the facts of mutual fund ownership.
According to the Investment Company Institute, an estimated 87.9 million
Americans own shares in mutual funds. These individuals hold about 80% of the
money invested in mutual funds. (Most of the remaining 20% is held by various
fiduciaries—such as banks and individuals acting as trustees, guardians, or
administrators.)
And, boy are these things popular! Between 1990 and 2000, total assets of mutual
funds rose from $1.065 trillion to $6.965 trillion. In 1980, less than 10% of
all U.S. households owned funds. By 2000, that number had grown to 49%.
The Investment Company of America has some interesting data about the type of
people who buy mutual funds, too. On balance, they are a mirror reflection of
the U.S. population as a whole. The typical fund investor is age 44, married,
and in the process of saving for retirement with median household assets of
$80,000. The majority is willing to accept at least a moderate level of risk in
exchange for moderate gain, and is not focused on the short-term ups and downs
in the market.
Fifty-seven percent have Individual Retirement Accounts (IRA’s). Over 75%
participate in an employer-sponsored defined contribution retirement plan. The
typical family in mutual funds has $25,000 invested. This represents almost a
third of their assets. Baby Boomers (folks hatched between 1946 and 1964) are
the largest group of mutual fund investors at 51%. Gen Xer’s (tots born after
1964) buy 22% of the funds sold. And, the Great Generation (those born before
1946) purchase the remaining 27%.
The book No Debt No Sweat! covers the basics of mutual funds, how to
invest in them—and how not to invest in them with topics like:
Starting At the Beginning (This is where we discuss the 3 basic types of mutual
funds: Stock, Bond, and Money Markets.)