These days, choosing where to invest your hard-earned money can be a daunting, fearful decision. There are more choices than there have ever been, and investments that were once considered safe-havens, or "blue chips", have gone by the wayside. When the market falls, everything falls. More importantly, in today's world of hyper-connected economies, when one market falls, they all fall.
So where to invest your money? Right now, many millions of people have their life savings invested in mutual funds. Mutual funds have been around for a long time, and have made some people enormous amounts of money. It is an industry that continues to grow as well. In Canada, there were a total of 25 million dollars invested in mutual funds in 1990. That number ballooned to $705 billion by 2008, and now sits at around 1.1 trillion dollars. In the US, mutual fund holdings were valued at $15 trillion at the end of 2013. That is more than the GDP of many countries!
What exactly is a mutual fund? In its simplest form, a mutual fund is a group of stocks that are held for a group of investors. Here's an example. Let's say you gathered all the people on your street and pooled your money together. You could buy stocks individually on the market if you wanted, and hope that they would do well. Or, you could hire a person, we'll call him a mutual fund manager, to buy those stocks for you, in exchange for a small fee, typically 1% to 3% of the total assets (stocks and/or bonds) that your pooled money bought. What you essentially have with your neighbours is a mutual fund. You mutually own the group of stocks together, and each person has a right to share in the growth of the stocks in the proportion that he/she contributed. If you put in $10 and I put in $20, then I would get twice what you would get if we both sold at the same time.
Mutual funds have some great advantages over trying to choose individual stocks. First, it allows you buy in partial amounts. You don't have to buy 100 shares of this and 200 shares of that. You just buy the amount of the mutual fund, determined by the Net Asset Value (value of the all the stocks held) per unit. You can even buy partial units, which makes it really easy to invest with small amounts of money. Secondly, you don't have to do all the research that would be necessary to purchase an individual stock. If you don't know how to read financial statements and such, paying someone to do this for is is wonderful. Third, there is a wide variety of mutual funds for people of every type of risk tolerance. Don't like risky investments, buy a government bond mutual fund. Love to watch you money grow, and don't mind the yo-yo of the markets? Buy an aggressive growth fund. Want to invest solely in oil? There's a fund for that - in fact, there's many. Mutual funds have exploded over the last few decades simply because of how they have made investing easy and accessible to "regular" people.
There is a downside to this of course. The biggest downside is that most mutual funds are not able to even match the growth of the market indexes (e.g. Dow Jones) on a consistent basis. Why? Well, mutual fund managers have a whole host of rules and protocols they have to follow when choosing investments that smaller investors simply don't have to follow. Also, because they are able to make huge purchases of stock, they sometimes have to make small purchases over time in order to not influence the price one way or another.
Another downside? Price. Some mutual funds charge you a fee just to buy the fund. Sometimes you have to pay the fee up front, or sometimes you pay the fee when you sell. These are called loads, and it is important to be aware of them before you buy into a fund. Also, there is an ongoing fee, called a Management Expense Ratio, or MER. This fee helps to pay managers, administrative expenses and trading costs. Depending on the fund, this fee can be between 1% and 3% or more of the value of the assets. That means if you have $100,000 in a mutual fund, each year you pay the fund between $1000 to $3000. Over many years of investing, that can add up to a lot of money.
Of course, it's ok to pay a fee for quality service though. isn't it? How could you hope to invest as wisely and smartly as people who have studied finance for years and live and breathe the markets on a daily basis? When you consider that most mutual funds aren't able to even beat the market on a consistent basis, perhaps we shouldn't be paying that fee.
So what choice do we have then?
Onstage at left - Index Investing. Remember, an index is something like the Dow Jones or the S&P 500. They simply track the performance of the stock market as a whole. And, lucky for us, there are mutual funds whose job is simply to buy the exact same stocks that make up the index, so that it gets the same returns. No research necessary. The great advantage of this is that the fees are exceptionally low, especially when compared with the more actively managed mutual funds. The fee for owning the Vanguard Total Stock Market Index Fund is a paltry 0.05%, or $50 per year. Compare this to the $3000 or more you would have paid to the fund managers for your actively managed fund that probably did not even beat the market, especially after paying the fees!
Not only this, but there are other investment vehicles that are like index mutual funds that have even lower fees. These are called ETF's, and they are designed to follow the markets indices as well. I will discuss these in a future article.
So there it is. Save yourself thousands of dollars by simply switching from an actively managed mutual fund, to an index mutual fund. There are hundreds, perhaps thousands, to choose from, and you can choose an index that suits your investing profile.
Of course, you may have other reasons for staying with your current mutual fund, and that is fine. In the end, it is simply important to be aware of all the options facing you when dealing with something as vital as your retirement fund or kids' college tuition.
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