The Gutman Group

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I’m going to be completely honest with you: I HATE mutual funds.

I personally believe that mutual funds are for lazy mules that lack a significant amount of brain power, are too lazy to learn the fundamentals of rolling around in big fat moneybags and would rather defer all the hard work and responsibility to someone else instead.

The thing is, 99% of the world’s population fits that description – and I don’t blame them.

That’s why this article will go over the concept of mutual funds; it will explain to you exactly what a mutual fund is, will help you determine whether mutual funds are right for you and will even show you how to properly invest into them.

So, let’s get started!

What is a mutual fund?

In short, a mutual fund is a professionally managed collective investment that pools money from many investors and invests it into stocks, bonds or whatever else the fund is dedicated to.

At first glance that above definition may seem as legitimate to you as a Ponzi scheme (see: our good old friend Bernard Madoff) but what if I told you that mutual funds have become immensely popular over the last 20 years – now with over one half of the households in American investing in them?

In fact, to many people the term “investing” simply means to buy mutual funds.

So, why do so many people invest in mutual funds as opposed to, say, stocks? Let’s take a closer look:

Meet the Professionals

First of all, and probably most importantly, mutual funds are managed by professionals. We live in a very high-powered, fast moving culture where, for most people, the concept of picking up a book and learning something is the equivalent of running a marathon with an anvil glued on to your right leg – it’s slow, painful and the results are seemingly dismal.

That’s why people feel infinitely more comfortable giving their money to someone that has already gone through many such marathons and knows exactly what he/she is doing – a professional. Not only do such investors save time by not having to manage their own money, they also feel safer because someone experienced is at the helm of their hard-earned moneybags as opposed to an emotionally unstable, inexperienced and uncertain person (see: yourself).

The thing is, your average “professional” consistently underperforms the markets – which is why it is so important to know how to pick the best mutual funds or maybe even consider taking control of the fate of your money yourself.

Now, if you have enough time to cruise around the interwebs [sic] and read my deceptively informative and incredibly whimsical scriptures then chances are you have enough time to learn how to invest for yourself!

Start by reading my free eBook introducing the stock market along with other articles in the “Business & Investing” section such as How to Read an Income Statement and reconsider putting off stocks. (You should still know all this information if you want to effectively and safely be able to invest in mutual funds on your own.)

On the other hand, if you would still feel more comfortable with a professional managing your money, then you are going to have to know how to pick the ones that are going to take your initial investment and actually grow it, so keep reading!

Don’t keep all your moneybags in one basket

Another reason people prefer mutual funds over regular stocks is because of diversification. One mutual fund can be invested into ten, twenty, thirty, forty or even fifty different stocks at one point in time – such massive diversification is nearly impossible for the average investor as it is simply too expensive.

If you’ve been an astute follower of mine, you may know that I’m not the biggest fan of diversification, but I will acknowledge that there are few better ways to reduce your risk level than by diversifying your investments into a variety of different securities.

Then again, by diluting your risk your profits are diluted by an equal amount – although the added safety is more than worth it for the average person.

It’s as easy as pie!

Another wonderful aspect that mutual funds have over stocks is the fact that they are easy. In the investing world, mutual funds are the equivalent of that promiscuous girl in high school that would be more than happy to “please” her male companions if they just paid some attention to her – and that’s why they’re so popular!

When you invest in stocks, you have to choose and open an online brokerage, you have to find your stocks, you have to research them, analyze and valuate them, and you have to sit at your computer screen all day and wait for the right time to execute a “buy” or “sell” order and then repeat the process for every single stock.

On the other hand, with a mutual fund you simply fill out a risk-tolerance profile with your mutual fund provider indicating how much risk you can tolerate (although I don’t agree with this in the slightest, it is commonly believed that the “riskier” investments are higher-yielding whereas the low-yielding investments are safer). Once you do that you just plunk a sack of cash on to the table, sign a couple of papers and then hit the beaches while all the work is done for you.

Of course, in exchange for all these luxuries you have to pay a management fee (typically 0.5% to 2% of assets) among a whole other concoction of fun stuff that lines the pockets of evil fund managers with gold teeth (although I fall privy to the same accusations and in fact charge a ridiculously high management fee – then again my returns are higher than 99% of my competition).

Choosing a mutual fund

Okay, so you’ve decided that you would like to go the path of mutual funds, congratulations! Now we just have to know how to choose them…

When you sit down with your bank, financial institution or whatever mutual fund provider you use, you are typically going to have the option of selecting which mutual fund you would like to be invested into.

If you have absolutely no idea how to distinguish between one or the other then you may just want to determine your risk tolerance level with your advisor and they will take it over from there. Then again, that’s the equivalent of giving your car keys to a random person on the street and asking them to take your car to a garage of their choice – you have virtually no idea or control over where your car goes and who is going to be fixing it.

That’s why I would recommend you get a little more interactive in your mutual fund picking – it’s your money after all!

Here are some of the things you may want to (and should) consider:

You daredevil you!

First and foremost you have to decide your risk tolerance.

Most people cash in their mutual funds when they retire so their holding periods tend to be many years – this means that they should be willing to expose themselves to a higher margin of “risk” (and ultimately higher returns) since short-term market fluctuations get evened out in the long-term.

If you have a good ten years or so before you cash in your mutual fund, you are going to want to pick a mutual fund that is heavily invested into stocks (which tend to be high yielding despite being “riskier”) and less-so into bonds (which are “safe” but low-yielding).

On the other hand, if you aren’t expecting a very long holding period or simply want a safe investment free of fluctuations or to simply beat inflation then you are going to want to have your mutual fund be more centered on bonds than stocks.

If you ask nicely, many mutual fund representatives will be able to provide you a list of all the individual investments a mutual fund has in its holdings and if you have somewhat decent stock-picking skills you will be able to determine if the management of the fund is right for you – then again if you can do this then you would probably be better off investing yourself.

Meet the Management!

Any decent mutual fund representative will admit to you that all mutual funds are virtually the same – it’s the management that distinguishes the great performers from the losers whose holdings get beaten with a sack of rotten potatoes by the markets.

So, how do you determine good management? By looking at past performance.

Many people will tell you that a fund’s past performance isn’t an effective indicator of future performance… but that’s virtually the same thing as saying that just because someone has had a history of violent behaviour and beating baby pandas with table legs doesn’t mean that they are more likely to be violent and assist in the extinction of fuzzy little pandas than someone with no panda-beating history.

And even if past performance wasn’t an effective indicator, would you rather invest your money with a fund that has underperformed the markets year after year or with one that has consistently ridden them like a master bull rider?

That’s what I thought.

You want to look for consistent performance, if a fund’s returns year-over-year are as sporadic as Kevin Bacon’s acting career than you may want to avoid it. It’s not unusual for a fund manager to get extremely lucky with a few stock picks, have the fund’s annual performance sky rocket and have a whole battalion of investors rush in as a result – only to horribly disappoint everyone in the end.

If a fund manager posts exquisite results one year doesn’t necessarily mean much but if that same fund manager consistently posts amazing results year after year then either the manager has a leprechaun working for him/her or is just damn good.

You are also going to want to see how the fund did in good years (bull markets) and bad years (bear markets). A fund’s exquisite returns may simply be as a result of riding a bull market into stratospheric highs and result in a deadly crash when the next bear market rears its big, ugly head.

That’s why investing in mutual funds with long histories (preferably over ten years) is better than ones with only a few years in their track record – the longer the time period, the better you can see how consistent the returns are, especially relative to market performance.

Many people will tell you that the higher a fund’s management fee means the better management is, but that isn’t always necessarily true. Your best way of knowing how good the management fee is by looking at past performance!

In the end

Just like how you should research each individual stock, you should also research each individual mutual fund. You want to look for consistency, expenses and especially compare mutual funds side-by-side.

Just like how you will never know how good a company’s financial standing is without comparing it to its competitors, you will never know how good a mutual fund is without comparing it to other mutual funds.

Obviously you want the best of the best, so you are going to want to compare each fund relative to each other. The mutual funds that consistently outperform their brethrens and with lower expenses are the ones you want.

And of course, you are going to want to take the righteous path of the Investor over the lowly Speculator and will definitely want to follow the ten investment commandments!

It’s that simple. Now go make some money!

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