Mutual Funds for Beginners

Summary

A mutual fund pools money from many investors and uses it to buy a portfolio of securities. Each investor owns a proportional share of the fund. The speakers describe mutual funds as a convenient way to gain diversified exposure without selecting and managing many individual investments.

Main points

• Diversification: A fund may hold dozens, hundreds, or thousands of investments. This can reduce the impact of any one company failing, though diversification also limits the chance of matching a single stock’s exceptional gains. It cannot eliminate investment risk.
• Who might use them: The guest says mutual funds can suit investors with a range of portfolio sizes because they simplify portfolio management and provide broad exposure.
• Types of funds and exposures: Funds may invest in stocks, bonds, or commodities such as gas, oil, and wheat. Stock funds can focus on company size or geography; bond funds can hold government or corporate bonds.
• Passive and active approaches: Passive funds seek to track an index. Other funds follow specific strategies and may have fewer providers offering them.
• Choosing a fund — suggested sequence:
  1. Decide how much of the portfolio should be in stocks versus bonds.
  2. Identify the investments or exposures that fit that allocation.
  3. Decide whether to use mutual funds or select individual investments.
  4. If using funds, choose a passive index-tracking approach or a specific strategy.
  5. Compare providers, fees, and the company’s history and scale.
• Small-, mid-, and large-cap: “Cap” means market capitalization, calculated as shares outstanding multiplied by share price. The guest gives approximate—not strict—definitions: small-cap below about $1–2 billion, large-cap at about $10 billion or more, and mid-cap between them. Micro-cap companies are generally a few hundred million dollars or smaller; mega-cap companies may be worth hundreds of billions or even a trillion dollars.
• How funds are held: Investors can buy directly from the fund company or hold a fund through a brokerage or custodian. In the latter case, the fund manager and broker are separate parties.

Costs and key figures

• Minimum investments vary widely. Some funds reportedly have no minimum and may accept $25; others require $500,000 or more. The guest says a typical minimum may be a few hundred dollars to about $1,000. Institutional share classes may have higher minimums—tens of thousands to $100,000+—and often lower fees.
• Brokerage transaction charges may range from $0 to about $50 per purchase or sale.
• Some funds charge a “load,” or sales commission, which may be as high as about 5%. In the example given, a $100 investment with a 5% upfront load leaves $95 invested. The guest generally recommends avoiding load funds and looking for no-load funds.
• An expense ratio covers fund operating and management costs and is deducted within the fund rather than paid as a separate bill. The guest describes ratios near zero as possible, about 0.5% as common, and around 1% or higher as high.
• The guest says many investors may be able to manage their portfolio with one to four funds.

Cautions and disclosures

• Mutual funds simplify investing but do not guarantee gains or prevent losses.
• Fee levels and minimums vary by fund, share class, and provider.
• No explicit “not financial advice” disclaimer is stated.

Presenters and sources

• Andy Panko, CFP, owner of Tenon Financial and producer of Retirement Planning Demystified.
• Andrew Scheer, host of Practical Personal Finance.