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What Is A Mutual Fund?

mutual-fundsWhat is a Mutual Fund?

NOTE: This post is part of an ongoing education series. This information is for educational purposes only. This information does not constitute investment advice. Please consult with your financial advisor before taking any action. For planning advice contact Polaris Financial Planning.

When I was a kid I loved looking at numbers, charts and graphs. I'm sure it was not the norm for my age but I remember looking at stocks in the news paper. Nothing like the smell of a newspaper and its ink on your fingers.

When you buy a stock, you buy a small piece of a company. If you put all of your money in one company you can make a lot if the company does well but you can also lose all of your money if the company goes broke. Remember Enron?

For more on the value of diversification read this....

According to Investopedia the modern mutual fund began in 1924.

The creation of the Massachusetts Investors' Trust in Boston, Massachusetts, heralded the arrival of the modern mutual fund in 1924.

NOTE: I will be talking about Open-end mutual funds. Closed-end funds are different and I don't recommend them.

A mutual fund allows people with small amount of money (<$10,000) the ability to invest in the stock market and reduce their risk (vs. one stock). Studies have shown that owning just 10 stock can limit your volatility (risk) by half and 30 stocks reduce your stock risk to almost the same level as owning 500 stocks (Standard deviation of 20.87 vs. 19.27). If you had to buy the stocks and invest just $3,000 in each one, you would need $90,000 to have a diversified stock portfolio. Each time you want to add money you would have to buy more shares in one of the stocks and, of course, pay a commission on the trade.

The modern mutual fund solves many of these problems. You can usually start with a few thousand dollars and can add money at any time. This type on investing can help keep your costs down.

Sadly 53% of Americans don't own any stocks.

Wikipedia lists these advantages for mutual funds....

  • Increased diversification: A fund must hold many securities. Diversifying reduces risks compared to holding a single stock, bond, other available instruments.
  • Daily liquidity: Shareholders may trade their holdings with the fund manager at the close of a trading day based on the closing net asset value of the fund's holdings.
  • Professional investment management: A highly variable aspect of a fund discussed in the prospectus. Actively managed funds funds may have large staffs of analysts who actively trade the fund holdings.
  • Ability to participate in investments that may be available only to larger investors: Foreign markets, in particular, are rarely open and affordable for individual investors.

I agree with all of the above points.

  • Ease of comparison: Picking a mutual fund is a lot like judging a dog show. You select the best of the breed which has the qualities you seek.

I disagree. It is very hard to pick a good mutual fund. Ironically, picking funds that have recently done very well can actually increase your risk. This is why I recommend and put my money in Index Funds.

Investing Skeptically - Women And Investing

Investing Skeptically is an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice, legal advice or tax advice.  If you are in the need of financial advice please contact  Polaris Financial Planning.  (Polaris Financial Planning LLC, is a “fee-only” registered investment advisor and does not receive money from anyone other than the paying clients.)

Young adults in the US have very low rates of financial literacy and only four states require a class on personal finance in High School.  When I give talks about investing I am often surprised by people of all ages that know very little about investing.  If you don't know how the system works it can be very hard to succeed.

This can make investing difficult for the average American but, women have some additional challenges and that is the point of this post.

Lower Wages

Data continually suggests that women make less than men.  Based on data from the Bureau Of Labor Statistics... 2010, women’s earnings were 81 percent of men’s.

Forbes (the online magazine) makes the argument that the actual gap is only 13.5% not 19%.  It is an interesting way to look at it but the result is that women DO make less and are likely to make less in the future.  I don't want to have a deep philosophical discussion about why this is but, this is the case.  Saving money is harder if you make less of it.

Longer Life Expectancy

Women tend to live longer than men.  Based on data from the CDC women should expect to live about 5 years longer than men.  Of course, it is great to live 5 extra years but,  you don't want to run out of money.

Lower Financial Literacy

Lower income and longer life create a challenge but according to FINRA women also know less about investing.  (FINRA, the Financial Industry Regulatory Authority, is an independent regulatory organization empowered by the federal government to ensure that America’s 90 million investors are protected.)

Women consistently score lower than men on measures of financial literacy, and this gender-based gap can negatively impact the financial well-being of women.  For example, financial literacy has been linked to several outcomes, including wealth accumulation, stock market participation, retirement planning...

FINRA's conclusion is based on research performed on RAND Labor and Population data.  Here is the study....

Here are a few highlights of the report.

Women tend to live longer than men, have shorter work experiences, lower earnings and levels of pension or survivors’ benefits.

These factors put women at a higher risk than men of having financial problems and of approaching retirement with little or no savings.

A contributing factor to low wealth levels of divorced women compared to men near retirement may be a lack of adequate financial literacy.

There is a burgeoning literature documenting low levels of financial literacy population-wide and the relationship between literacy and savings behavior.
The financial literacy index for women is about 0.7 standard deviations lower than for men (p < 0.01).


These factors can all compound and result in the premature depletion of  retirement funds for women.


Let me give two examples and make a couple of  little graphs. (Note:  These are just theoretical examples and oversimplify reality)

The first example is for a theoretical man:

- starts investing today at age 22 and retires at 62.

- income $60,000 per year. (while working)

- saves 10% ($6,000 per year).

- Makes a 10% return per year while working.

- changes to a more conservative portfolio in retirement, making 8% per year.

- He collects $18,000 per year from Social Security in retirement and another $42,000 from his investments. (total of $60,000)

- His funds last until to age 108 - long past his expected life span of 76.  (note:  inflation is assumed to be 3% and income numbers at retirement are adjusted by this factor)

The second example is a theoretical woman:

- starts investing today at age 22 and retires at 62.

- income $54,000 per year. (10% less than the man - actual difference is likely greater)

- saves 9% ($4,860 per year) (Low financial literacy often leads to lower savings)

- Makes a 9% return per year while working. (Low financial literacy often leads to lower savings)

- Changes to a more conservative portfolio in retirement, making 8% per year.

- She collects $16,200 per year from Social Security (Her SS is lower because it is tied to your income and she made less) in retirement and another $37,800 from her investments.  (Note:  She only trying to match her working income of $54,000 not the $60,000 the man enjoys)

- Despite her smaller withdrawals, the funds only last until to age 77 - short of her expected life span of 81.  After age 77 she will have to live on just the Social Security of $16,200.    (note:  inflation is assumed to be 3% and income numbers at retirement are adjusted by this factor)

Common SenseWhat to do?

Get a financial education and higher a "Fee Only" Financial advisor.

I would start with the book "Common Sense On Mutual Funds" by John C. Bogle.  It has a little math but you can handle it.  Mr. Bogle is a financial genius and founder of the Vanguard Mutual fund company.  (NOTE:  I do not get ANY payment or commissions from Vanguard )

You can also pick up magazines like Kiplinger.  I would not follow any of the specific advice that they give but it will help you learn the language.  This will help you make better choices.

If you need any other ideas or suggestions let me know.