What is a Mutual Fund

The term mutual fund is a common and widely-used term throughout many different media channels.  Mutual funds are used in retirement plans and are available to the investing public through traditional and online brokers.  So, what is a mutual fund?

A Combined or Pooled Investment

A mutual fund is a type of investment where many people pool or combine their money together for a professional investment manager to use to invest in individual stocks, bonds, and other types of securities.  Each mutual fund is governed by a prospectus which contains the rules about how the money in that specific mutual fund can be invested and what types of individual securities (stocks or bonds) may be held in the mutual fund.

Diversification

When an investor invests their money in a mutual fund they essentially own a small (usually very, very small) piece of all the investments owned by the mutual fund.  An investor can invest $100 into a mutual fund that owns stock in 500 different companies or they can invest their $100 in one or two shares of a single company (depending on the price of the shares).  This is called diversification when we can spread our investment across many different securities.  I think this demonstrates why mutual funds have become such a popular and useful investment tool.  For the same amount of money (our $100) we can purchase a piece of 500 different companies or a piece of one company – this is an example of how we can very effectively diversify our investments by using something like a mutual fund, even with very few dollars.

Professional Management

Along with the feature of diversification, mutual funds provide professional management by employing a portfolio manager whose job is to monitor the mutual fund’s investments, managing the process of buying and selling individual securities, and making sure the mutual fund is following its prospectus.  If the objective of a mutual fund is to invest in a specific index then the management of the investment doesn’t require much management because the mutual fund simply invests in the securities that are in the specific index.

While some mutual funds invest in a specific index, others are actively managed by portfolio manager (or a portfolio management committee or team).  We call these actively-managed mutual funds or active mutual funds (as opposed to passive or indexed mutual funds).  The portfolio managers in active mutual funds make investment decisions to buy or sell specific securities based on the objectives identified in the fund’s prospective and on their opinions about how they might generate better returns than a benchmark to which they compare themselves.  A benchmark is usually some type of index that is used as a standard to which the mutual fund’s results are compared.  The portfolio manager’s job in an active mutual fund is to generate higher returns that the benchmark to which the fund is compared.  We call this “beating the benchmark”.

Initial Investment Barrier

Although this example provides a simple demonstration of how a mutual fund works and the benefits investors receive from those mutual funds, we have encounter a barrier in real life that prohibits us from investing in a mutual fund with our first $100.  Almost all mutual funds require an initial investment for $2,000-$3,500.  As a $100 Investor who has been working to accumulate their very first $100 to invest, the mutual funds make themselves unavailable.

I Like Mutual Funds, But….

One of the original reasons that brought me to start this $100 Investor project was the dirty trick that mutual funds play on investors by requiring large initial investments which is very frustrating and extremely discouraging for a $100 Investor when they have worked to save their first $100 and are told it isn’t enough and that they need to save more.  Investing can be a daunting topic and can trigger subconscious fears and concerns that are challenging to recognize, let alone address.  For an independent individual investor to make a decision to start investing, work to gather their initial investment, engage in some self-education, and to open an account which leads to some excitement and anticipation then be told that you can’t invest in a mutual fund can cause a person to wonder why they went to the effort and trouble.

For the $100 Investor, mutual funds are very good investment tools (we sometimes call them investment vehicles) that can’t be used until later once a portfolio has a larger capital base.  I am a fan of mutual funds, especially mutual funds that invest in a specific index (many times called an indexed mutual fund).  I get frustrated with mutual funds because an investor needs at least $2,000 – $3,000 to invest in one, single mutual fund and an investor would need $36,000-$50,000 to be able to invest in a diversified portfolio of indexed mutual funds.

By necessity, the $100 Investor will not be able to use (or buy) mutual funds with their first $100.  Mutual funds are tools that will become available after an investor has built a larger portfolio or amassed a larger capital base.

We will talk about other important aspects of mutual funds in future posts which will include the following:

Mutual fund fees

Types of Mutual Funds: Open-end funds and Closed-end funds

Mutual fund share classes

How mutual fund shares are purchased or sold

And here’s the necessary legal & compliance stuff:

Disclosure & Disclaimer

I am a practicing certified public accountant (CPA) and am licensed in the states of Oregon and Washington and own a CPA firm, CPA Worx LLC, and have practiced for more than 25 years.  I teach accounting at Oregon State University and have taught at the college/university level since 1997. 

I also own a registered investment advisory firm, Peacock Investment Worx LLC.  In the $100 Investor project, I am not offering recommendations of any kind nor am I providing tax, accounting, or legal advice.  I do not receive any type of compensation, of any kind, from the brokers, companies, mutual funds, exchange traded funds, websites, authors, publishers, investment managers, or anything or anyone else that I mention in this project.  True, my clients compensate me for my work and advice.  Many people do not want to invest on their own so I provide my investment services for a fee through Peacock Investment Worx LLC.  But the $100 Investor project is my way of helping anyone and everyone that wishes to invest on their own.  I want to support the independent investor.

Peacock Investment Worx LLC can be found online at www.peacockinvestmentworx.com and on Facebook at 100 Dollar Investor.

CPA Worx LLC can be found online at www.peacockcpaworx.com and on Facebook at CPA Worx.