What are mutual funds?

By: Michael Saville

Mutual funds are very popular. In fact, they are the one of the most popular investments on the market today. What does that mean in numbers? There are over 10,000 different funds with over $4 trillion in investments!!

Why are they so popular? For some, it is because of their great returns. Others like funds because they are easy to buy and sell. Still others like them because they are diversified and less risky.

A mutual fund raises money from investors to invest in stocks, bonds, and other securities. It is a package made up of several individual investments. When those investments gain or lose value, you gain or lose as well. When they pay dividends, you get a share of them. Mutual funds also offer professional management and diversification. They do much of your investing work for you.

Mutual funds have been around since the 1800's, but didn't become what we know today until 1924. Even then, they did not become a household word until the 1990's, at which time the number of people owning them tripled. A recent survey shows that 88% of all investors have at least some of their money in mutual funds.

A mutual fund is a special type of company that pools together money from many investors and invests it on behalf of the group, in accordance with a stated set of objectives. Mutual funds raise the money by selling shares of the fund to the public, much like any other company can sell stock in itself to the public. Funds then take the money they receive from the sale of their shares (along with any money made from previous investments) and use it to purchase various investment vehicles, such as stocks, bonds, and money market instruments.

In return for the money they give to the fund when purchasing shares, shareholders receive an equity position in the fund and, in effect, in each of its underlying securities. For most mutual funds, shareholders are free to sell their shares at any time, although the price of a share in a mutual fund will fluctuate daily, depending upon the performance of the securities held by the fund.

Most investors pick mutual funds based on recent fund performance, the suggestion of a friend, and/or the praise bestowed on them by a financial magazine or fund-rating agency. While using these methods can lead one to selecting a quality fund, they can also lead you in the wrong direction and wondering what happened to that "great pick."

Despite the distinctive characteristics of mutual funds - performance, management philosophy, & investment objectives - your specific selections should be chosen within the context of your overall financial plan. Examining features such as past performance are not where your studies should begin. The point of departure is you; your financial priorities; your resources; your approach to investment diversification; your willingness (or lack thereof) to accept market volatility; and your time horizon for a particular investment.

Total Returns are fun to look at and brag about, but simply looking at a fund's total return for the past year is not necessarily a good measure of a fund's quality. For example, investors often talk about how well a specific fund did last year and how happy they are with that performance -- say a 16% return in an equity income fund. Well, in a given year that may or may not have been a good return for an equity income fund. That fund may have under-performed many or most other equity-income funds for the year. Returns should always be measured in context with how other similar "categorized" (e.g.. equity income funds, growth funds, small cap funds, etc.) funds have performed. So don't get overly excited by a funds total return until you see how it compares to other similar funds over the same period.

As it is often said, past performance can't predict future results. But when comparing performance of funds, it is also wise to look beyond the results of one or two years. Most experts suggest that a larger "window" of 5 to 10 years gives a clearer picture of historical performance. Has your fund or the one you are considering performed well over this longer time horizon? Any fund can have one good or one bad year, but if you are investing for the long term, you want a fund that has a consistent track record. While that record doesn't guarantee future results, it gives you an indicator that may be to your advantage.


About Author

Michael Saville has over twenty five years experience in providing finance and investment advice. He has written a free five-part short course on 'no load mutual funds' which is available at http:///buy-mutual-funds.com