PF blog regulars have likely been met with “introduction to mutual fund” blog posts every couple of weeks. Its almost a right of passage for bloggers to write about as the mutual fund is generally accepted as the most important bucket your money will ever sit in.

Wikipedia does a wonderful job of describing exactly what a mutual fund is:

A professionally managed firm of collective investments that collects money from many investors and puts it in stocks, bonds, short-term money market instruments, and/or other securities.

Mutual funds come in all shapes and sizes, but they are built around the same premise. If many people pool their investments together, the administrative costs are reduced and we can pay someone to manage investments for us. This implies that everyone invests in the same thing of course. In essence, when you purchase a mutual fund, you are buying shares in the mutual fund, not shares of stocks. The mutual fund manager will take the money you gave him (or her) and invest it the same way as everyone else in the fund. This way, your shares of the mutual fund are no different than anyone else’s.

So what are the advantages of mutual funds?
Primary reason for mutual funds: You’re paying something to manage your money, and its cheap. It’s a wonderful feeling to know that I can pay a guy $150 a year to manage my $100,000 (cheap index fund). 99,999 out of every 100,000 people are better off leaving all their money in mutual funds than investing themselves.

Mutual funds also allow the ’set it and forget it’ attitude we lazy Americans love so much. Bills are paid automatically, why not take care of my investing too? They can do that. Some fund families will debit your checking account each month while others will even be a part of your direct deposit. My Roth IRA works via direct deposit thanks to Vanguard

Finally the choices of mutual funds allow for almost perfect diversification based on your risk tolerance. There are thousands of funds out there. If you’re interested in just undervalued tech stocks in southern Thailand, you can probably find a fund that’s just as interested. Most of us are content with the standard diversification strategies though. Thanks to mutual funds you can be fully diversified with a few thousand bucks instead of the $100,000 you would likely need were you to pick stocks.

And the disadvantages?
Yes there are disadvantages to mutual funds. The biggest disadvantage is your don’t control your money. Yes the investor can pick and choose their funds, but you have no say-so in what is said and done within the fund.

While on the subject of control, when you want to sell your mutual fund shares there’s a caveat. Mutual funds are not traded on exchanges, and so the price is not always changing. The NAV (net asset value) is calculated at the end of the trading day. If you wish to sell at 10:00 AM, the sale will not register until the end of that trading day. A bad day on the market can hurt the value of your mutual fund shares. Of course you’re smart enough not to pay attention to daily market fluctuations, aren’t you.

There are also fees, and depending on the fund you can get dinged from every angle. Some fund charge fees up front (called front end loads). Others when you sell (back end loads). There are marketing fees known as 12b-1 fees (marketing and distribution) and management fees. These are all charged in deductions of your balance with the mutual fund.

What else do I need to know about mutual funds?
There are so many sub-topics of mutual funds. Today we just want to introduce you to the concept. This is Weakon 205; 305 and 405 will come in time and we’ll look into some of those sub-topics. In the meantime check out Morningstar.com and CNN Money’s mutual fund education section.

Related posts:

1. Weakon 305: Mutual Funds, Intermediate
2. Mutual Funds Stuck In Between a Rock & a Hard Place
3. Supplement to Weakon 206 and 207
4. What Happens When a Mutual Fund Goes Out of Business?
5. Weakon 206:  Asset Allocation

Related posts brought to you by Yet Another Related Posts Plugin.

Liked this post? Hated this post? Hate me? Email me and let me know: Philip@weakonomics.com