What Are Mutual Funds

So, you want a Ferrari? So do I. How about a boat, a vacation house, or a paved path to financial freedom?  Well, there are several ways to achieve these goals, and investing in mutual funds is a great place to start.

What are mutual funds? A mutual fund is basically a pool of money that is professionally managed and invested in assets.  Professional management is an important feature to mutual funds. Most people don’t have the expertise or time to make strategic investment decisions. The fund managers are highly educated and trained to make these decisions with the goal of the best possible returns. Mutual funds will vary depending on its investing objectives. Some fund companies and managers may invest in blue chips, some in small companies, and others in international stock. There are three main types of mutual funds; stock funds, bond funds, and money market funds. Here, we will be discussing stock funds.

Mutual funds can be a great investing vehicle, however, they should not be the first investment that you make. I follow an investment hierarchy. This hierarchy places investment categories in the order that you should invest in and proceeds as follows; Step 1. Savings accounts/Money markets. Step 2. Bonds/Personal property. Step 3. Mutual funds. Step 4. Individual stocks. Step 5. Commercial real estate. Step 6. Commodities. Step 7. Rare collectibles – precious metals, paintings, and memorabilia such as a Barry Bonds autograph, er…uh, an Alex Rodriguez autograph, um, fine, a Roger Maris autograph. So, before investing in mutual funds, you should have money in a savings account/money market and bonds.

Stock mutual funds invest in a number of companies. For example, a tech-heavy blue chip fund might have holdings in Apple, Microsoft, IBM, Google, HP, Motorola, AMD, and Sony, to name a few. So, the overall performance of the fund will be based on the individual performances of the companies. Contrary to individual stocks, mutual funds will not flourish or sink based on the holdings of one company, but the performances of all of the companies combined.

To illustrate this concept, think of a stock mutual fund as a cruise ship and an individual stock as a ski boat. Both are two different vehicles but have the common goal of leaving the dock to have an enjoyable time in the rough seas. In order for the cruise ship to turn, either in the correct or incorrect direction, it takes time and a large number of individuals. As for the ski boat, it can head in either direction rapidly with just one person. So, mutual funds are less risky but are not immune to peaks and valleys. They can make you great wealth but it usually takes some time, which makes them a good tool for retirement planning.

There are many types of stock mutual funds. Large fund companies such as Fidelity, Vanguard, JP Morgan, American Century, Dreyfus, John Hancock, Janus, and Neuberger Berman, to name a few, offer all types funds for every investment objective. Most of these companies offer funds directed at a specific time to meet your goal, such as retirement.  Fidelity’s Freedom Funds are a great example. These funds use a mix of stocks, bonds, and short-term funds. The managers for these funds will invest your money more aggressively when you’re younger and will change your investments accordingly to become more conservative as you near your goal of retirement.

So, what are mutual funds? Well, everything we’ve just discussed and a lot more. We’ve only begun to explore the world of mutual funds. Other areas I will discuss with you in future articles will be Lump Sum vs. Automatic Investment, Fees, Focused Funds, and The Prospectus. So, once you’re a successful mutual fund investor, you can jump to the more risky and superfluous investments and maybe get that Roger Clemens jersey, um…or that Mark McGwire bat, well…fine, a Hank Aaron bat.