Educational Programming Video
The Value Line Mutual Fund Survey
Program 2: What is a mutual fund? Part 1
This is the second part of a series about Value Line's Mutual Fund Survey and about mutual funds. The series is designed to describe our mutual fund publication and, more importantly, teach investors how to use it to select mutual funds that are most suitable for their individual needs.
This session will start by answering the very basic question, "What is a mutual fund?"
This question may seem to be very obvious at first, but it's really not. In fact, there are many different kinds of investments that fall under the broad category of "mutual fund." They include the very common open-end mutual funds, the less common closed-end mutual funds, and a new entrant, exchange-traded mutual funds.
These different investment products are called mutual funds because they all provide a very similar service; they allow individual investors to pool their money so that a professional money manager can invest for the group. The way in which each of these mutual funds operates, however, differs.
We will discuss the more arcane closed-end and exchange-traded funds at a later date. For now, the more common, and widely used, open-end mutual funds are our topic (by definition, an opened end mutual funds are ones that stand ready to buy or sell their shares to investors at any time). Indeed, when someone mentions the words "mutual fund," it is the open-end variety that first comes to mind. This is largely because of the explosion in the number of open-end mutual funds that took place in conjunction with the bull market of the 1980s and 1990s. Today there are well over 11,000 open-end mutual funds in existence. It seems as if you can't turn a page in a newspaper or a magazine without seeing a company advertising its funds.
Legally speaking, mutual funds are corporations or trusts whose sole purpose is to invest their shareholders' assets. The pooling of assets from multiple shareholders allows an entity to diversify more broadly than a single investor would be able to. Thus, where an investor with, say, $5,000 could purchase only a small number of stocks or bonds, a mutual fund with total assets of over one million dollars is able to buy far moreoften the number of holdings in a fund's portfolio is over 100. The ability of an individual investor to inexpensively put his or her eggs in more than one basket, better known as diversification, is one of the major benefits of owning a mutual fund.
Different funds go about selecting stocks or bonds for their portfolios in very different ways. A goal is established when a fund is created, and the money manager selected to run the fund must comply with the mandate. This brings us to the second and third benefits that mutual funds offer: specific investment goals and professional management.
With a mutual fund, you know, before you get in the door, what your fund's investment objective is. If you want income for retirement, you can find a fund for that. If you want no income but lots of growth potential, you can find a fund for that. If you want a fund that invests only in health-care stocks, you can find one for that, too. Not only can you find one of each, but you can usually find a number of funds that invest in the same way, allowing you to compare them and, ultimately, pick the one that seems best for you.
You also know who the fund's manager is before you buy. You can research whether or not this seasoned professional's tactics make sense to you, what his or her educational background is, and the manager's success with the fund you are considering, as well as his or her success at the helm of other funds. All valuable pieces of information when making your investment decision.
Other benefits and specifics of open-end mutual funds will be discussed in my next session. After that you should have a pretty solid understanding of what open-end funds are.