The Wealthy Investor Tyrone Jackson

Mutual Funds Explained

Explaining mutual funds does not have to be complicated. When people decide to invest in the stock market, they usually begin by opening an investment account at their bank. Financial advisors at the banks often direct investors to open a “managed account,” where the investment decisions are made by the bank’s investment team. These advisors tend to build a portfolio based on mutual funds instead of individual stocks. What exactly are mutual funds and how do they work?

Explaining mutual funds is simple. It is a professionally managed investment product that uses a pool of money to buy stocks, bonds, and other types of assets. The securities that make up a fund are bought according to the specified investment goals of that fund. These goals can range from very conservative (income preservation) to extremely aggressive (capital appreciation). After an investor decides his investment goals, a financial advisor will build the portfolio. By combining different types of funds, the advisor limits the client’s overall risk exposure so that the portfolio does not experience extremes of growth or loss.

There are many types of mutual funds. Some, such as equity funds, buy only stocks. Others, such as a fixed income fund, will buy only bonds. These two types of funds usually have different goals. An equity fund will usually offer a higher return in exchange for higher risk. A bond fund is more stable but will not return as much on the investment. The income generated in these funds is derived from stock dividends and interest on bonds, which are then distributed to fund holders.

A newer type of fund that has become extremely popular is an exchange traded fund, or ETF. The assets in these funds are based on an entire index, such as the S&P 500, or a sector, such as technology. These funds give the investor broad access to the marketplace and are often considered ideal holdings for IRAs. Since they basically mirror an index, the fund managers are less active, which leads to lower costs for the investor. They also trade like stocks, so they are easier to buy or sell than funds, which can have holding periods. These funds can be quite large: for example, SPY, an ETF that tracks the S&P 500, has more than $270 billion assets under management.  

So, what are the downsides of having a managed account that invests in mutual funds? In a word: fees.

Financial advisors charge fees for their services. Mutual funds also price in the cost of maintaining the fund, known as a load, when you either buy or sell them. These fees can become quite expensive, especially if you are selling one mutual fund to buy another.

The simplest and best way to avoid these fees is to become knowledgeable about the stock market and handle your own investments directly. Look at these two stocks that I have been recommending to my students for the past five years. You will notice that they both have doubled in value.

Costco Wholesale Corporation (COST) 5 year chart 

American Tower Corporation (AMT) 5 year chart

If you’d like to learn how to achieve financial independence, let me guide you and show you tried and true strategies that will enable you to reach your investment goals.

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