Stocks
Young Fools
March 25, 1998

What are Mutual Funds?

Mutual funds have grown really popular in the last few years. What are they? Well, imagine that you want to buy stock in a dozen companies, but you only have $100. You're not going to get very far, are you? You might be able to buy one or two shares of one or two companies, but you probably can't buy all you want. However... you've got a friend who also has $100. In fact, there are 20 of you, each with $100. That means that if you all pool your money together, you'll have $2,000. That's definitely enough to buy a few shares of a bunch of companies.

Mutual funds are like the situation above, but bigger. If you invest in a mutual fund, you put in some money. Thousands of other people do, too. One reason people love mutual funds so much is because you don't have to do much work with them. You send in your money, and someone else invests it. Each mutual fund is run by a mutual fund manager, who might have dozens of people working for him, studying companies. The manager is the one who decides which stocks to buy, and which ones to sell. Some mutual funds have billions of dollars in them and own chunks of hundreds of different companies.

There is a wide range of mutual funds. Some invest only in bonds or international companies or in gold and precious metals. Some invest only in healthcare-related companies, while others invest in all kinds of things. Some are very risky and try to earn high rates of return. Others are very conservative and don't earn you much more than a bank account.

In general, mutual funds are not a bad idea. But you know what? (Shhh... this is another thing that most people don't know.) Mutual funds generally just don't do as well as you'd expect. Most of them underperform the market! What does that mean? Well, let's assume that by "the market" I mean the 500 biggest American companies. So if these 500 companies increased in value by 15% in one year, the majority of mutual funds didn't do that well.

Among those 500 companies are some which had amazing years and grew quickly, maybe even doubling or tripling in value. Others dropped like rocks. But on average, the group rose by 15%. You'd think that professional mutual fund managers would be able beat that, right? After all, they each probably have a college degree or two in business. Shouldn't they be able to pick the better companies and not buy into the losers? They probably should, but most of them don't. Pretty sad, huh?

If you're going to invest in a mutual fund, you should study how it has done in the past. There's no guarantee that it will continue to do as well, though. You might be thinking, "Well, if most mutual funds do worse than those 500 companies, I'd be better off just investing in those 500 companies." You know what? You're right. Only on your own, it would probably be impossible for you to invest in all 500 companies. You need something like a mutual fund that invests in the particular group of companies you're interested in, like those 500 companies. This way, you and thousands of others will essentially be pooling your money and will be able to be invested in a big group of companies. What I've just described is called an "Index fund."

Stocks

What is Stock?
The Case for Stocks
Stock Prices and Value
How Do Stocks Move?
Dividends
What are Mutual Funds?
What are Index Funds?
Stock Splits