Understanding mutual funds
Created on Thursday, 21 March 2013 14:31 Last Updated on Thursday, 21 March 2013 14:31 Published on Friday, 22 March 2013 06:01 Written by Damon Carr Hits: 456
My childhood friends and I were very close. We spent practically every waking moment together—playing sports, video games and just hanging out. Looking back on life from an adult point of view, I must say, “we were spoiled “BROKE” kids.” None of us worked or even thought about doing anything to create an income. We just took what our parents gave us and improvised. We were very creative with the little resources and money that was available to us.
One thing that we did that was smart is we combined our money and our resources allowing us to do and purchase things collectively that we could not do on our own. We called this process “Ante-up.”
If we wanted pizza, a group of five of us may have one to three dollars per individual. Individually none of us could purchase a pizza. By “Anteing up”—pooling our cash together, collectively we can purchase a pizza and all of us would share a piece of the “pizza pie.” This Anteing up or pooling your cash together process is the foundational concept of Mutual Funds.
I believe that mutual funds are the investment vehicle of choice for my target audience—ordinary upwardly mobile people. Since I’m in the business of “Helping Ordinary People Make Extraordinary Progress Toward Their Financial Goals—Regardless of Current Financial Status, I’m always looking at what’s best for the common man.
As I look into my crystal ball, I can state with confidence three things about the stock market. The stock market will rise (Bull Market). The stock market will decline (Bear Market). Fortunately, it has risen far more times then it has declined. As a result, the majority of investments do well the majority of the time. Consequently, simply being in the market over an extended period of time—five years or more, you have a high probability of your investments earning a reasonable rate of return. As investors we want to reduce the likely hood of harm by making wise decisions. The best decision you can make when you’re investing is—DIVERSIFICATION!
Diversification is the process of spreading your investments around. In other words, it’s following the old adage of not putting all your eggs in one basket. If you have the ability to invest in 100, 300, 500 or 1,000 of America’s and even some foreign country’s brightest and best companies, you have the closest thing you’ll get to a guarantee that your investments will make money. In order to lose money all 100, 300, 500 or 1,000 companies would have to go broke at the same time. Can you imagine Microsoft, Wall Mart, Dell Computer, Home Depot and 150 other companies all going broke at the same time? I can’t. If by chance that was to happen, your Certificate of Deposit isn’t safe either because the whole economy will have collapsed.
How does the common man invest in 100, 300, 500 or 1,000 companies with limited cash? Many individual securities have large minimum denominations—meaning you have to purchase a block of securities of an individual firm spending a minimum amount of $10,000. If you don’t have $10,000 you can’t invest. If you did manage to save $10,000 and you decided to invest this money, you would have a highly concentrated portfolio. Let’s say that this particular security turned out to be Enron, MCI or K-Mart? There goes your $10,000.
Mutual Funds works to the advantage of the common man because you can make a one time investment with as little as $250 or you can engage in a process called dollar cost averaging and systematically invest as little as $25-$50 dollars per month. Furthermore, your contribution—no matter how large or how small will purchase you a pro-rata share of 100, 300, 500 or 1,000 securities of well-established companies. So if one of those companies happens to be Enron, your portfolio is not as devastated because you have a vested interest in 100-1,000 other companies—many of which may be doing great.
Mutual Funds allow small investors—common man type of investors to pool their cash together (Ante-up). This cash is used to buy hundreds to thousands of securities of established companies that these individual investors could not do on their own. Each individual who invests with the mutual fund has a pro-rata share or piece of the pie based on his or her contribution.
So if you’re like me and you consider yourself to be a common man, 90-100 percent of your investments should be with mutual funds. Your retirement plan including, 401(k), 403(B), 457 Plan, IRA should be invested with mutual funds. Your college savings including Education Savings Account and 529 plans should be with mutual funds. Your wealth-building portfolio should consist of mutual funds.
Why do I believe strongly in this? You get professional management, diversification, convenience, record keeping, liquidity, minimal investment requirements, and regulations!
As an aside, it’s important to note that no two mutual funds are exactly alike. There’s a science to selecting high qualify mutual funds. I’ll share ideas on how to select qualify mutual funds in an upcoming article.
(Mortgage and Money Coach Damon Carr is owner of ACE Financial. Damon can be reached at 412-216-1013.)
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