In case you missed my newsletter I would like to define a mutual fund again. If you like you can see my other definition posts on stocks and bonds.

A Mutual Fund is a legal entity where the manager collects money from other people and invests that money in multiple stocks, bonds, and other securities. Those people who the manager collected money from own shares (percent ownership) in the mutual fund. The main benefit of a mutual fund is diversification. It is basically a fancy version of the expression ‘don’t put all your eggs in one basket’. So if one of the stocks or bonds in the fund fails, there are other stocks/bonds to make up for it. I want to tell you a story. You’re walking down the street with a basket full of eggs. The eggs represent your money; the basket represent a security. Suddenly the bottom of the basket breaks and all the eggs come crashing to the ground. All of them are completely destroyed. You’re really sad because you were planning on making yourself an omelet. Now what if you had a second basket and you had some of your eggs in that basket? You originally had the exact same total number of eggs, it’s just split up between multiple baskets. Now even after one basket broke you still have some eggs to bring home. A mutual fund is essentially a large collection of baskets that your eggs are split between. Imagine a basket full of other baskets.

The typical mutual fund has 2 major types of fees that the shareholder has to pay. The first fee is the management fee which is some percentage of the fund’s market value. This fee can be very significant and should be carefully considered. If the management fee is 2%, the portfolio has to go up in value 2% in order for you to break even. The second fee is a commission (or load). A fund can be front-loaded, back-loaded, or no-loaded.

In a front-loaded fund, the manager removes part of your invested money before they buy securities. For example: Susan invests 100 dollars into a front-loaded fund. The fund pockets 5 of those dollars, and the remaining 95 dollars is invested into the stock or bond markets. In a back-loaded fund, the manager removes some of the proceeds when you sell your shares. However, the amount they take out decreases the longer you’ve held the shares. For example: Susan sells within one year of purchase $100 worth of shares of a back-loaded mutual fund. The fund pockets 5 dollars and you are given 95 dollars. If Susan sells within 3 years of purchase $100 worth of shares, the fund pockets 2 dollars and you are given 98 dollars. A no-load fund does not charge a load. These funds are often called index funds. A fund can only be one type of load (front, back, or no).

The shareholder in addition to the management fee and load may be required to pay for additional fees such as transaction costs. You need to be careful when you invest in mutual funds due to these fees. For example: You invest 100 dollars into a mutual fund that is front-loaded (at 5%) and there is a management fee (at 2%). The value of the stocks the fund is invested in goes up 6%, but you end up losing money due to all your gains being eaten up by the fees. Imagine fees as a snowball that is rolling down a snowy mountain. The snowball over time gets larger and larger. Eventually it gets so large it crushes you.

As I’m writing these to help my readers, I would be very appreciative of any input in regards to what I should write next. If you want me to write about a particular topic, please contact me. If you would like to submit a post to my blog, please contact me.

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