Mutual funds are the best investment vehicle for people like you and me. If you read any finance blogs, you’re likely invested in them yourself (good job). I’ve talked about them before in the College of Weakonomics series, so if you’re a regular reader you should be good to go. If you’re new to mutual funds, go read up on them in my college and then come back here.
Most of us that own mutual funds are invested primarily in stocks. More conservative investors will also have some bonds in various mutual funds. As a reference point, I have about 8% of my retirement accounts in bonds right now. Mutual funds will also hold on to some cash. Now cash can be anything from a money market account to short-term government t-bills. This allows the mutual fund to have some money sitting around to make investments. So say they are evaluating a new stock for the fund and they want it to be 1% of the fund. The mutual fund will sell another holding and sock the cash away until they’re ready to invest it in the new stock.
For fun we could say a mutual fund might have 10% in bonds, 87% in stocks, and 3% in cash. Now last year a mutual fund with these holdings would not have performed well. But what if instead the mutual fund manager got scared of a bad year and pulled out of stocks some more and put it in cash. So now the balance might be 10% bonds, 50% stocks, and 40% cash. He would have done much better and his loss wouldn’t have been nearly as bad.
This has been happening quite a bit in the florescent lit offices of mutual funds lately. All investors are moving to the sidelines to wait for some kind of recovery. Mutual funds are forced to sell when their investors pull out, so they are likely keeping extra cash on hand to avoid more selling. This is in addition to them being scared to invest at all and just sitting on cash.
But I ask you, should mutual funds be doing this? The job of the mutual fund is to invest your money as deemed by the investment strategy of the specific fund. If it is a technology fund, it should be invested in technology. An index fund should be invested in the index. If I wanted cash, I could just pull out the money and put it in cash myself right?
I’ve been back and forth on this a few times. Here are the opposing arguments:
A) I’m investing with your fund so you will buy stocks and bonds, if I feel I should 40% of my money in cash, then I’ll pull out 40% from the fund and put it in cash myself.
B) I’m investing with your fund in order to maximize the potential returns, so do what you’ve got to do to protect and grow my money.
After marinating on this for a few days I decided I want my mutual fund to stay in the investments they are supposed to be. The role of the mutual fund is not to protect assets. If you want your assets protected at all costs, you should be with a hedge fund. Mutual funds tell you from the start that there are risks involved with investing in stocks or bonds and that the fund could fall significantly. While hedge funds have a tarnished name, there are funds that exist and operate just like a mutual fund. The difference is in a down market they might move all the way into bonds or cash to protect you from potential losses.
To sum up, I want my mutual funds to stay invested in what they are supposed to be. If I want my money in cash, I’ll move it there myself. If I want to pay someone to try and protect me from potential down markets, I’ll use a hedge fund.
What do you want your mutual fund managers doing?
 By The Weakonomist |
The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice. |
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I wonder if the rate that mutual funds get on cash holdings are much better than individual rates since they can pool much larger amounts of cash.