Certain securities are called “pooled” investment funds. These securities provide an efficient way of diversifying a portfolio. Even small dollar amounts invested in a broadly diversified pooled fund can spread investment risk across many individual issues. A U.S. investor attempting to purchase a broad sample of European stocks, for example, would face daunting information and trading costs if he elects to purchase individual securities. Pooled funds, however, offer significant advantages because they spread costs across thousands of customers, and risk over hundreds of securities.
One type of pooled fund is a mutual fund. A mutual fund pools money from many investors and invests in a portfolio of financial assets. A mutual fund is created by an Investment Company. These companies, such as Fidelity or Vanguard, manage the pools of money on the investors’ behalf. The pool owns securities—usually stocks or bonds—according to a pre-determined investment theme. For example, a U.S. Bond Fund may own hundreds of U.S. government and corporate bonds; a Far East stock fund may own hundreds of stocks from firms located in Japan, China, Australia and other Asian nations.
The fund is managed by a team of investment professionals. The team determines what investments to buy, sell, and hold. Today, there are approximately 800 different investment companies offering thousands of mutual funds to investors. The mutual fund investment management structure saves the investor from the task of investigating and monitoring the financial prospects of many thousands of companies. Even with the “instant” information available on the internet, this is a formidable and full-time job for even the most dedicated of investment professionals.
Mutual funds are perhaps the most popular investment option available to investors today. According to the Investment Company Institute, investment companies oversee assets worth approximately $15 trillion dollars.
Although mutual funds address the need to diversify a portfolio across many different investment areas, it is wise to remember that a mutual fund is a pooled asset product operated for a fee. Costs differ substantially from fund to fund; and, it is vital to identify all costs so that your investment profits do not leak out of your pocket simply because expenses and fees remain unnoticed.
Bottom Line: A Mutual Fund is a fully assembled and professionally managed investment portfolio. If you want to invest, you don’t have to bet a lot of money on a few stocks or bonds—remember what happened to Enron, General Motors, Eastman Kodak, Pan-Am Airlines, or other “safe, blue-chip” companies? A Mutual Fund offers broad-scope diversification so that you can participate in portfolio growth without worrying about an imprudent concentration of wealth in a single company. All else equal, keep costs to a minimum. Don’t overpay for a good track record—see our previous posts on the ‘track record’ topic. Good track records may come and go—high fees are forever.