A mutual fund is a collection of cash pooled by investors that is professionally managed and invested according to the philosophy of that mutual fund. The major advantage to mutual funds is instant diversification of your portfolio without having to manage the investments directly. Most mutual funds are a collection of many different stocks, bonds, cash and equivalents. Some mutual finds are based on a stock index, such as the S&P 500. These mutual funds invest their portfolio in the exact proportion of every stock in that particular index to produce a return identical to the index. Index funds are becoming popular because their performance is easily ascertained and the management fees are typically very low because there is no art or skill – only ensuring the portfolio is in line perfectly with the index.
The basic components of a mutual fund are the total assets, the composition of those assets, the net asset value, management fee percentage, load or no-load, and turnover ratio (stock funds only).
- Total Assets: The overall value of all the investments and cash held by a mutual fund. Mutual funds are usually made up of a combination of stocks and/or bonds and cash. An important piece of a mutual fund to research is its asset distribution. This will tell you what percentage of the fund’s total assets are cash, stock (should disclose the percentage from each sector and the top companies’ stock that are held), and any bonds or other investments.
- Net Asset Value (NAV): Is the “share price” of a mutual fund. Like a company, a mutual fund issues shares to its investors. The total assets of the mutual fund minus any liabilities divided by the number of shares outstanding for the fund equals the net asset value.
- Management fees: Every mutual fund is managed by finance professionals. These managers are paid and the cost of their salaries is covered by the management fee of the mutual fund. Every mutual fund has a different management fee percentage. A higher fee does not necessarily correlate to higher returns of better management. This is something that will impact your overall return as an investor because you must first pay for the management before you get to pocket any profits. Traditionally, savvy investors look for funds with the lowest management fees for their category.
- Load versus No-load: A “load” in mutual fund lingo means a commission. Funds with a Load carry an additional broker’s commission in the form of a percentage of the NAV, just like the management fee. There is no data to suggest that funds with a Load outperform No load funds in any way. This is just another sneaky way for those sneaky brokers to pull one over on less-informed investors. There is no reason to invest in a mutual fund with a Load, unless all of your 401k options have Loads…then your company is just cruel.
- Turnover ratio (stock funds only): Mutual funds that purchase stock as part of their portfolio have a metric known as the Turnover ratio. This ratio is meant to show how often the management is making stock trades. This is important because every time a trade is made, broker’s fees are incurred. Typically, funds with high turnover ratios also tend to have higher management fees as a result of the costs incurred from the increased trading activity.
- Resources: A great free online tool is available at Morningstar.com. Morningstar has a plethora of research, data, and a fund screener. There is, of course, the premium version that requires a paid membership, but I find that the tools available for free are still perfectly adequate.
It is important to remember that mutual funds are regulated by the SEC but each one has free reign within the SEC guidelines to invest the cash contributed by its investors in whatever combination of investment instruments they feel provides the best portfolio. When looking to purchase a mutual fund, be sure of what you are looking to get out of the investment. Obviously, the first and foremost objective is to make a return. To that end, think broadly about what types of investments you expect to perform well over the time period you wish to invest. Then seek out mutual funds that contain portfolios similar to your tastes with the right management fee, NO LOAD, and take the plunge.
Tracking the performance of the Market Mondays virtual portfolio has yielded a positive return to date. Aflac (AFL) and Datascope (DSCP) have returns of 5.94% and 5.81% respectively. The portfolio value has increased by $540 on a $9,197 initial investment. This week’s pick is a mutual fund, going along with the theme of the post, and is meant to bring some balance to this portfolio. AIG Retirement I Government Securities (VCGSX) has a NAV of $10.73 with total assets of $203 million. This is a NO LOAD fund and has a ridiculously low management fee of 0.66%. The assets are 78% government bonds, 4% mortgage bonds, 4% corporate bonds, 1% foreign bonds, and 13% cash.
3 Comments
Rick Edelman once wrote that you should avoid Mutual Funds that have too high of a NAV. The reason he gave is that some funds have so much money to invest that they are watched very closely by the masses and hence the notion that a fund of this size would buy into a stock has the tendancy to over inflate the share price.
What’s you take on this?
Jack, while I know less than nothing regarding investing I would venture a guess that this is the “herd mentality” that earmarks the Stock Market and groupthink in general. The little guy always follows the big guy since it is assumed it must be the correct decision. (Insert assumption maxim here).
As in all things, people are more comfortable leaving Big Guys to do their thinking.
NAV is not necessarily an indicator of total assets, which is what Ricky-boy really meant. The really “large” funds that people watch and try to anticipate are considered “large” because of their total asset value, not the NAV.
I would stay away from funds with a high NAV for a different reason. As with shares of stock, the more shares you have the less per share gain you need to make returns. By owning a fund with a high NAV, you get less shares for your investment than you would have with a fund having a lower NAV. Therefore, it takes a higher return per share the higher you go NAV-wise to produce per share results similar to funds with a lower NAV. I hope that makes sense…
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[...] week’s Market Mondays featured an overview of mutual fund basics and key concepts to fund investing. There is one correction to last week’s post in regards [...]
[...] ground from last week, but is still positive over the purchase price with a 2.96% return to date. AIG Retirement I Government Securities (VCGSX) has continued to do well with an increase in NAV of 1.25%. The most recent addiition to [...]