Investing
101 — Starting with Mutual Funds
By Jeffry L. Sessions
Investing money can be a powerful
learning experience as you see how money grows. On average
(we are using statistics from the last 150 years), invested
monies can expected to increase in value about three-fourths
of the time. In fact, if you look at the returns over any
10 year period, there has rarely been a time (only once) that
the money you put into an investment account was less than
what you started with.
When you think about it, we live
in a remarkable time in the earth’s financial history. The
booming wealth that grew dramatically in the second half of
this last century continues to be distributed widely and deeply
throughout the world’s pockets and purses. This expansion
of wealth has created a growing interest in how to invest.
One of the best ways to get experience in investing is using
mutual funds. They are simple, safer than stocks and you have
thousands of funds from which to choose. The purpose of this
article is to provide:
How Mutual Funds Got
Started
Until the early part of the last
century, the principal way for anyone to invest with confidence
was to hire a professional money manager. Not many could afford
such a person. It was not profitable for a professional money
manager to take on a client who had less than $100,000, and
very few people had that kind of money.
In 1924, three enterprising business
people from Boston decided to create a way for people who
had a little money to pool their savings and give it to a
professional manager. This concept, created over 80 years
ago, was called “The Massachusetts Investors Trust.” This
simple idea became so popular that one year later approximately
200 people put their money together to total $392,000. This
opened the way for virtually anyone to invest money with the
same advantages as the affluent. When people discovered that
they could “mutually” accumulate enough money to give to a
professional manager, it sparked a wave of interest that continues
to expand today with little signs of stopping. Over time,
other funds with different investment objectives were created
and the mutual fund industry was well on its successful way.
Obviously the concept was a tremendous idea inasmuch as, today,
we have almost 84 million investors who have given these funds
around $7,000,000,000,000 (that’s trillion with a “T”).
So, you want to invest some of
your savings or extra income into funds for the future? Here
are a few principles to help you understand the benefits (and,
yes, there are accompanying risks) of investing.
Getting Started with the Basics
Before we talk about mutual funds,
it is important that we have a working definition or basic
understanding of stocks and bonds. (I know we could talk about
additional types of financial instruments but, for now, let’s
keep it simple and limit our discussion to stocks and bonds).
Stocks are investment vehicles
that represent ownership in a company. When you buy a share
of General Electric stock you own a share of that company
(however small it may be).
Many stocks not only grow in
value over time but they also pay a dividend (or a return
of profits). Dividends usually come in as a quarterly check
in the mail or they can be reinvested to buy more shares of
stock.
A bond is a loan. When you buy
a bond others use your money on the condition that you will
be paid interest. You lend your money to a company or the
government and they will pay you a specific amount of interest
for an agreed upon length of time.
Mutual
Funds — Keeping it Simple
As mentioned, a mutual fund is
a way for a group of investors to combine their money so it
can be professionally managed.
A fund may have one or multiple
managers who have responsibility for investing your money
into either stocks or bonds or a combination of the two. You
will become a shareholder in a fund much like owning a stock.
A mutual fund has many advantages
over buying individual stocks and/or bonds. Let’s discuss
the more important of them:
There is risk in investing in
only one stock or bond. Diversification is the practice of
dividing your money into a variety of investments. The risk
we take by investing in stocks can be reduced significantly,
because when one investment goes down another might go up.
Here’s why:
If you invest in only one stock,
then you have an equal (50/50) chance that on any given day
that stock will either make money or lose money. A typical
mutual fund owns anywhere from 50 to 500 stocks. Over the
last 150 years the average rate of return has been about 10%.
Keep in mind, this is an average… we saw the dot com funds
lose as much as 75-80% from March of 2000 to February of 2003.
Remember, investing your money
is not a game. This is serious business, and if your objective
is to make money for retirement, college or a long-term goal,
there is great safety in diversifying your money through mutual
funds.
In buying a mutual fund, you
are hiring a professional manager at a very low price. Few
people think they know more about investing than an experienced
mutual fund manager. You will get someone who has experience,
who researches out what to buy or sell and trades on a very
cost efficient (commission-free) basis. Not only that, whether
you have $50 to invest or $500,000, you are getting the identical
manager!
As mentioned above, when you
buy a mutual fund, new or small investors can buy stocks at
a very reasonable price. Imagine trying to buy a $100’s worth
of stock on a monthly basis. If the broker or on-line service
charged you even $10 a trade, you would have an immediate
10% loss of your money. That is not a good way to begin each
month!
Another advantage of mutual funds
is having immediate access to your money. You can either have
a check sent to you or wired to your account when you sell
it.
With individual stocks and bonds
it usually is more difficult to quickly gain access to your
money. Some funds have check writing privileges to use as
you would your local bank.
Additionally, it used to be that
only the super wealthy enjoyed special treatment. Today mutual
funds allow you to know how the fund is doing as well as a
customer service representative to help you with any question
or need.
Mutual funds also help you at
tax time. They will keep track of any earned dividends and,
like a professional bookkeeper, the fund will send you a statement
telling you what you need to know to pay taxes on any investment
gains (or losses).
So, convinced that mutual funds
are the way to go? There are a couple of other things you
will want to consider.
Practical
Advice to Keep in Mind
Continually educate yourself
Unless you hire an experienced
professional advisor, you must take investing seriously. As
mentioned, you are taking risks with your money. Investing
your money includes such variables as:
- domestic vs. international
funds
- small, medium or large company
funds
- value versus growth oriented
funds
- taxable, tax-deferred vs.
non-taxable accounts
- manager styles and tenure
- whether interest rates seem
to be headed up or down
This all may seem confusing at
first, but if you spend time regularly learning about investing
(which you are now doing) it will become clearer and easier
over time. Your confidence will grow and it can be a very
rewarding experience.
Don’t let your emotions get
in the way
You are probably very aware of
how Murphy’s law reliably comes into play when you get involved
in investing — that the market will go down on the day after
you decide to commit some of your hard-earned money in the
market. Seriously, if the market has a bad day, you must step
back and check out your emotional heart rate when you hear
what is coming across the news. What the media says will affect
your emotions. The media (television, radio, and magazine,
newspaper, and internet commentary) is in the business of
keeping your attention long enough to listen to their advertisers.
Many times their preferred method is to appeal to two prominent
emotions — greed and fear.
Remember the headlines during
the dotcom or telecom bubble of the late 90’s and early 2000?
- “We are in a new economy,
now”
- "The Dow is going to 30,000”
- “The internet will dominate
our lives”
- “Don’t worry about price,
just buy these great companies”
Doesn’t this sound like greed
to you?
Then, when the market sank to
almost half of its value, think about what the media was saying
in early 2003:
- “Terrorism will dominate our
lives”
- “Iraq-shock and awe”
- “The Dow is going to 5,000”
- “Unemployment: headed for
record highs”
This sounds like fear to me
Remember, when the media show
us all the things that we need to have to “keep up with the
Joneses,” we tend to react with feelings of greed. When we
see the media report about the negative or tragic events happening
to others, we tend to react with fear. Don’t succumb to either.
It is not a good idea to make decisions when you are emotionally
charged or agitated. Ordinarily, the best time to make important
decisions is when you feel secure or “settled” about the course
you are about to take. Conversely, haven’t your biggest regrets
come when decisions were made impulsively — reacting to the
emotions of the moment?
If you have properly diversified
your investments the sensational stories you hear should not
get in the way of your investment plan.
It is still true: “Buy low
and sell high”
It is a proven fact that investors
who react to the market climate do not do very well. Multiple
studies have pointed out that during the early 80’s up until
2002, the average return on an index (stock) mutual fund returned
about 10%. However, the average mutual fund investor,
during that same time, had about a 3-5% return.
Why?
The answer is found in investors
reacting to what is happening to the markets. They see their
investments go down and want to get out at the wrong time
— they sell low. Then, when they see that the market is recovering
and are sure there is a recovery, they jump back in and buy
high. That is not the way to make much money. When we sell
low and buy high we can expect to make around 3-5%. If you
are invested in high quality, diversified mutual funds with
good managers, then let them decide what to sell and what
to buy… and when.
Anything worth doing is
worth doing well
Don’t get impatient with the
process. Do you remember the time you started out learning
to ride a bike or try out roller skating? You probably didn’t
do very well… at first. But if you kept at it then you found
increased success and it became a great benefit to you. Getting
started in investing is very much the same way. Don’t expect
to be perfect at this either. If you aren’t very experienced,
then start small and you will get better at it over time.
Use
good judgment
A word of caution: Don’t get
too overly confident at first, especially if you find that
you are exceeding the averages by an unusually wide margin.
You may have hit on a “hot” sector initially (natural resources
and China/India funds were some big winners last year). You
may be fooled into thinking that you are smarter than you
really are. Only invest money that you are willing to see
decline. Keep educating yourself, don’t let your emotions
get the best of you, stay diversified and keep an eye on good
managers who have experience in investing. By following these
basic guidelines, you may find that investing can be both
profitable and very enjoyable.
A
Final Word
We all know that we are supposed
to have a solid foundation of savings that are not at risk.
Make sure that is in place first. You must have some reserves
that will help you weather the storms that inevitably will
come. We know that we are given money and means as a stewardship
and we must treat them as such. Could it be that part of our
test in life is to see how we will manage our discretionary
money? Do not be tempted to take these safer funds and put
them at risk. Money is a means to an end and the end is not
to accumulate wealth at the expense of family, our relationship
to others and God. We must manage these divinely given resources
wisely and prudently.
