Copyleft 2006. Michael Saville
People use mutual funds a lot. In fact, they are one of the most popular things to invest in right now. In numbers, what does that mean? There are more than 10,000 different funds with investments worth more than $4 trillion!!
Why do so many people like them? For some, it's because they make a lot of money. Some people like funds because it's simple to buy and sell them. Still others like them because they have a wide range of investments and are less risky.
A mutual fund gets money from investors to buy stocks, bonds, and other securities. It is a group of investments that work together as a whole. When the value of your investments goes up or down, you do too. You get a share of the dividends they pay out. Mutual funds are also managed by professionals and have different investments. They do a lot of the work of investing for you.
Mutual funds have been around since the 1800s, but they didn't become what they are today until 1924. Even so, most people didn't know about them until the 1990s, when the number of people who owned them tripled. A recent survey found that at least some of the money of 88 percent of all investors is in mutual funds.
A mutual fund is a special kind of company that pools the money of many investors and invests it according to a set of goals. Mutual funds get the money they need by selling shares of the fund to the public, just like any other business can do. The funds then use the money they get from selling their shares, along with any money they made from previous investments, to buy different types of investments, like stocks, bonds, and money market instruments.
When people buy shares in a mutual fund, they give the fund money in exchange for a stake in the fund and, in a way, in each of its underlying securities. Shareholders in most mutual funds can sell their shares at any time. However, the price of a share in a mutual fund changes every day based on how well the securities held by the fund are doing.
Most investors choose mutual funds based on how they have done in the past, what a friend says, or what a financial magazine or fund-rating agency says about them. Using these methods can help you choose a good fund, but they can also send you in the wrong direction, leaving you to wonder what happened to that "great pick."
Even though mutual funds have different qualities like performance, management philosophy, and investment goals, you should choose which ones to invest in based on your overall financial plan. You shouldn't start your research by looking at things like how it did in the past. The starting point is you, your financial goals, your resources, how you plan to diversify your investments, how willing you are (or aren't) to deal with market volatility, and how long you plan to keep an investment.
Total Returns are fun to look at and brag about, but a fund's total return for the past year is not always a good indicator of how good it is. For example, investors often talk about how well a certain fund did last year and how happy they are with that performance, such as a 16 percent return in an equity income fund. Well, that might or might not have been a good return for an equity income fund in a given year. For the year, that fund may have done worse than most or most of the other equity-income funds. Returns should always be compared to how other funds in the same "category" (such as equity income funds, growth funds, small cap funds, etc.) have done. So don't get too excited about a fund's total return until you see how it compares to other similar funds over the same time period.
As is often said, what happened in the past can't tell you what will happen in the future. But when comparing the performance of different funds, it's also a good idea to look at more than just the past year or two. Most experts agree that a "window" of 5 to 10 years gives a clearer picture of how things have worked in the past. Has your fund or the one you're thinking about doing well over this longer period of time? Any fund can have a good or bad year, but if you are investing for the long term, you want a fund with a consistent track record. Even though that record doesn't guarantee that things will go well in the future, it does give you a clue that may work to your advantage.
