What on Earth is a Mutual Fund?

Welcome to what on earth is a mutual fund.

A mutual fund is a pooled group of investments like stocks, bonds, debt, and even managed futures. The large mutual fund companies are names that everyone knows like Vanguard and Fidelity. According to the Website Statista the mutual funds at the re are 7636 at the end of 2020. That is more mutual funds than there are stocks on the US Stock exchanges. In fact worldwide there are somewhere in the neighbor of 9000 individual publicly traded stocks.

Although frequently argued by a couple of fund companies Massachusetts Investor’s Trust and State Street make claims to creating the first open end mutual fund companies. Open end Mutual fund companies are said to be making a continuous offering at a price called NAV or Net Asset Value. Net Asset Value is derived by taking Total Asset Value by the total number of shares.

Mutual Fund Asset Allocation

Mutual Fund pool a large number of stocks or bonds together and offer each investor in the pool a % slice or tranche of the pool.

Sometimes i like to describe one in the following way. Let’s pretend like we are baking a cake. We would need at least some of these ingredients: Flour, Sugar, Baking Powder, Eggs, Flavoring, and perhaps some Baking Soda. These ingredients are all mixed together to form a cake. Once baked you cannot tell where the eggs end and the sugar and flour begin. What you do know is that you own a small slice of it.

As the total cake grows so does the value of your slice.

Why is Asset Allocation Important?

Well, I like to use the following analogy. Let’s pretend like we are going up in an elevator in in a tall building like the Transamerica building in San Francisco. One elevator has one cable and the other has 6. In the case of an earth quake which elevator would you rather be in. Obviously the one with six cables, because the one with the single cable will take you for the ride of your life if the building shakes.

For example, thinking of it another way, you would not want all your eggs in one basket. If the basket drops? Well you get the picture.

Two Types of Mutual Funds

There are closed-end funds and open-end funds.

The closed-end funds usually buy a basket of invest product with little to no change in the mix. So basically there are a fixed number of stocks or bonds and a fixed number of shares. It can trade at a discount to value.

The open-end fund is said to have a continuous offering it continually offers shares. It will have a specific investment objective like Large Capitalization or Small Capitalization components. You would always want to make sure it does not have style drift. In other word, it does not buy investments other than its objective. You bought it for a reason, and it should not drift from that.

Asset Allocation Overlap

When several mutual funds contain the same specific invest products, they are said to have overlap. That is why you would not want to own several large cap value or small cap value funds at the same time. If they share a large percentage of the same stocks and those stocks go down. You could see a loss in value of all your mutual funds.

So be careful.

By the way if you are looking for ways to make money to invest in mutual funds try this free E-Book.

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