Investing
in individual common stocks can be an expensive endeavor. Commissions to the broker
on every buy and sell can add up over time. Many investors instead choose to invest
in mutual funds based on the misconception that mutual funds do not charge commissions.
In reality, mutual funds, even funds that are no-load funds, can be costly to
buy, sell or simply hold. In coming weeks, I will discuss the various types of
mutual funds and the different fees and expenses a mutual fund investor can face.
This week, I will cover the basics of mutual funds.
What
is a Mutual Fund and How Does One Work?
A
mutual fund is an open-end investment company. Most mutual funds are corporations,
with a state charter like any other corporation. This financial instrument provides
an investor a more simple, convenient manner in which to invest rather than purchasing
individual common stocks, bonds, etc. A professional manager, the mutual fund
manager, manages the underlying investments of a mutual fund. Mutual funds "pool"
money from investors to invest and reinvest into different financial instruments
such as stocks, bonds, cash-like instruments, and even futures and options in
some funds. The fund manager is the person who decides what underlying instruments
to purchase in a fund, as well as when to buy, hold or sell these securities.
There is no limit to the
number of investors in a fund or the number of shares offered to the public, although
some funds "close" voluntarily for various reasons. Therefore, mutual funds are
said to engage in continuous offerings. When an investor purchases shares of a
mutual fund, that investor owns shares of the fund. Each share represents a percentage
of ownership in all of the fund's underlying securities. The fund manager uses
the pool of money to purchase the underlying securities he or she feels will help
obtain the particular objectives of that fund. Earnings on the securities are
distributed as dividends or capital gains (if a security was sold for a profit).
These dividends and/or capital gains are paid out in proportion to the number
of shares an investor owns. In some cases, a fund may make a capital gain payout,
even if the fund had a negative return for the year.
Mutual
funds offer investors a simplistic form of diversification. In order to have a
properly diversified portfolio, an investor should have a mix of different investment
instruments across different industries, and within different companies of an
industry. Before investing in mutual funds, an investor should assess his tolerance
for risk, and determine his goals: long-term growth and appreciation of assets,
or a more conservative, income-producing portfolio? The correct mutual fund to
invest in solely depends on the objective and goals of each particular investor's
situation.
Regulatory
Issues Concerning Mutual Funds
The Securities and Exchange Commission
(SEC) regulates every mutual fund. In compliance with SEC regulations, all mutual
fund companies must provide an investor with a fund prospectus. A prospectus describes
the fund objectives, history, background of managers, financial statement, etc.
Mutual funds are always considered a new issue, therefore, they are continuously
required to provide a prospectus. If a fund is part of an initial public offering,
a prospectus must be filed with the SEC and given to prospective buyers of the
offering.
All funds are required
to provide investors with periodic reports providing information on the fund and
how the investments in the fund are performing. Investors also receive an annual
statement from the fund.
Our
Approach
At The Henssler Financial
Group, our investment philosophy states that if you have less than $50,000 to
invest, mutual funds are a more viable option to help you formulate a well-diversified
portfolio by offering a much more cost-effective way to invest than by purchasing
individual common stocks. Mutual funds offer instant diversification, and allow
the investor exposure to many stocks in many industries with one purchase. In
coming weeks, we will review various types of mutual funds and mutual fund fees
and expenses. For more information regarding this topic, please contact The Henssler Financial Group at 770-429-9166 or comments@henssler.com.
