Mutual Funds

Mutual funds are the practical way to buy and hold collections of stocks. There are different types of mutual funds: actively-managed funds and passively-managed funds. But warning: only a tiny number of active funds outperform index funds in the long run, and those funds are unpredictable in advance. Moreover, the vast majority of active funds do far worse. This page will help you learn the basics about actively-managed mutual funds. Contents:

Select Video Tutorials about Investing With Mutual Funds

Playlist for Actively-Managed Fund:

All are excellent videos. The transcripts can help you make best use of your time.

Commonly asked questions about Mutual Funds.

1 Mutual funds

2 Passively-managed mutual funds, or index funds
(Find much more about the important special case of index funds here.)

3 Actively-managed mutual funds

4. Fund-of-funds

Mutual funds

What is a mutual fund?

Main article: What are Mutual Funds? (video)

A mutual fund is a collective investment that pools together the money of a large number of investors to purchase a variety of securities—like stocks or bonds. When you purchase a share in a mutual fund you have a small stake of all investments included in that fund.

Which mutual fund is right?

Main article: The Truth About Mutual Funds (video)

The first question to explore is whether the fund should own stocks, bonds, or some combination. That must be answered by your ability, willingness, and and need to take investment risk.

The second question is ultimately about costs but you might think that it is about choosing a fund manager. That question is whether to choose an actively-managed or a passively managed fund (usually called index funds). Almost invariably, the answer the best answer is to choose a broadly diversified fund at the lowest possible cost. These are usually index funds (find here on this site). An exception might be if a high income investor needs to be in a municipal bond fund and there is not an appropriate index fund offered.

What is a “load” or “no load”?

Main article: The Truth About Mutual Funds (video)

The word load is just another word for sales commission. You can easily buy no load funds buy buying directly from the fund itself.

What are the ways that sales charges might appear?

Main article: The Truth About Mutual Funds (video)

There are three primary methods of charging investors for service. One is an up-front fee which is deducted from the amount you invest. A second would be a back-end fee if you sell before a specified number of years. The third method is an annual fee which is a percentage of the total amount you have invested with them.

The goal of this website is to help you find the wisdom and confidence to invest wisely without paying any of these sales charges.

Are there additional fees and expenses to own a mutual fund?

Main article: The Truth About Mutual Funds (video)

All mutual funds (and ETFs) have annual operating expenses that cover administrative costs. These are always listed under the unfortunate name: expense ratio. Additionally, when a fund buys and sells there are transactions costs which are not publicized–these are sometimes substantial with an actively-managed fund. Your goal as an investor is to understand how these fees—which look misleadingly small—make a huge impact in your long-term returns. These costs matter. Once you understand that you will find it easy to identify excellent mutual funds from all others.

What is net asset value? (NAV)

Main article: Net Asset Value (Boglehead wiki)

The net asset value for the fund is simply the sum of the values of all the shares they own. Some funds own thousands of shares but when the market closes this value is easily computed and the value of each investor share of the fund is published. If you bought or sold a share that day, this published NAV is the price you paid for received for that transaction.

This is the main difference between a mutual fund and an exchange traded fund (ETF) which is traded all day long like a stock. When you buy or sell a share of ETF your transaction is with another investor and the price to you agree to might be higher or lower than the actual NAV of the fund.

How do I make money with a mutual fund?

Main article: What are Mutual Funds? (video)

The first way is through appreciation, which is when the fund shares go up in value. The second way is through dividend payments which are distributed to owners on a regular basis.

What is an open-ended fund? closed-ended fund?

An open-ended fund is most common. There is an incentive to grow these funds so the fund-manager earns more. These funds dynamically grow and shrink.

A closed-end fund is when money is raised to create a fund with a fixed size. Thereafter, individual shares of the fund may be traded with other investors but the overall fund does not grow or shrink.

On this website you will find a series of short videos about closed-ended mutual funds from the Khan Academy because closed mutual funds have similar features to an exchange traded fund (ETF).

Passively-managed mutual funds, or index funds

What is an index fund, or what is passively managed?

Main article: Passive Investing With Index Funds

The majority of funds are actively-managed. A true index fund is passively managed with, for stocks, market value (or, market capitalization) weighting. The fund’s objective would specify a relevant index that it tracks. Ultimately an investor should look to fees (beginning with load fees and expense ratio) since the true index fund is a strategy to achieve the broadest diversification at the lowest possible costs.

Actively-managed mutual funds

Are managed funds OK if I don’t wish to manage my own investments?

Main article: How much should you pay for financial advice?

This is a huge problem. The reason why I answer NO is because once you are smart enough to recognize and find a good advisor, I believe you are smart enough to do this by yourself. But yes, that means a lifelong commitment to learning and understanding the basics. It’s not hard. But I recognize that it is not for everybody.

The other extreme is the full-service firm where you are paying for services that you rarely need. A better compromise would be finding a fee-only advisor that will put you into broadly diversified index funds at the lowest possible cost.

Marketing is a powerful thing, but you can often tell when you are being sold as opposed to trying to find the product you know you wish to buy. It’s an easy thing to make a managed fund look like it is superior to an index fund. That is why everybody needs this basic level of education. Everybody also needs to guard against their tendency to think that they are somehow different: a better automobile driver, able to recognize a good fund manager, etc.  Use this website to learn why you need to understand why index funds are the winners game.

Investing is so complex, surely a manager can do better than average.

Main article: A paid salesman can always beat the index fund

Ah, that’s what they want you to believe. Check the article. There is an abundance of evidence to the contrary

Is it ever ok to own individual stocks and bonds?

Main article: When is it appropriate for an individual to trade stocks?

Investing and speculating are different. If you wish to be an investor, then it is better to be more diversified. If you choose to own individual stocks for your own education or entertainment, keep this a small portion (e.g. 5% or less) of your overall investment portfolio. If this is a consequence of a company stock purchase plan, recognize that this combines with the human-capital that you have concentrated in one company and be smart about becoming more broadly diversified when you can do so with penalty.

Bonds are different. There is no advantage to diversifying the highest quality bonds so you may be able to reduce costs slightly by choosing individual Treasury Bonds. Although many find the convenience of a low-cost high quality bond fund to be worth the small cost. Learn about bonds in another section of this website.

Fund of funds

What is a balanced fund?

Main article: How many funds are necessary for an investor to own?

A balanced fund usually refers to a fixed combination of stocks and bonds. For instance, The Vanguard Balance Index Fund is 60% total stock market and 40% total bond market. The advantage to a product like this is convenience and that it automatically re-balances to maintain the same level of risk (controlled by the ratio of stocks/bonds).

Three cautions: First, a balanced fund is not always comprised of low-cost index funds. Second, a balanced fund is a fund of funds is sometimes more expensive because of the extra layer of fund management. And third, while balanced funds are always fine in a tax-advantaged retirement account, there are times when they might not be efficient to hold in a taxable account.

What is a target date fund?

Main article: What are Target Date Funds?

Like a balanced fund, a target date investment is a combination of stock and bond funds. The difference is that this product is designed to become more conservative as you approach retirement age. Here again Vanguard sets the standard because their products are based on index funds and there is no additional cost to manage this fund of funds.


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