Continuing with our NextGen, we will next take a look at Mutual Funds. Most investors know that it is important to not just own one stock, but instead to be diversified across many different stocks as a way to reduce risk. The problem is that when first starting out, most people do not have the money to be able to diversify. They do not have the resources to be able to go buy a few hundred different companies. Even if they did, most investors do not have the time or knowledge required to research thousands of potential companies and decide which ones to buy.
One possible solution for these dilemmas is to use one (or several) mutual funds. Mutual funds are essentially a way for investors to be able to pool their money together to purchase many different stocks. The mutual funds will combine all of the monies from the different investors and use the aggregated amount to purchase stocks, bonds, or other types of investments. Each investor then effectively owns a pro rata amount of each security that is owned inside the fund. For example, if a mutual fund were to use 3% of the fund’s total aggregated value to purchase company XYZ, effectively 3% of each individual investor’s money is invested in company XYZ.
Mutual funds are also beneficial for those who do not have the experience or expertise at picking individual securities. Mutual fund managers are often surrounded by a full team of analysts whose jobs are to research different investment options. Often mutual fund managers will meet with the prospective companies CEOs and CFOs to be able to get a sense for how they are making decisions.
Mutual funds also have the ability to specialize in a certain sector of the market. For example, a mutual fund may be a small-cap domestic fund. This fund’s managers and analysts will be responsible for purchasing small companies that are domiciled in the United States. These types of funds are often able to specialize in specific areas based on the expertise of their managers and analysts.
By combining several different mutual funds, an investor is able to not only be diversified by owning more than one company, but is also able to be allocated across different sectors and locations.
One term you may have heard in relation to a mutual fund is NAV. The NAV (net asset value) is the price per share of a mutual fund. The NAV is figured by taking the total value of all of the securities in the fund, and dividing it by the total number of shares. If the total value of all the securities in the fund is $10,000 and there are 1,000 shares outstanding, NAV $10.
Our firm utilizes several carefully selected mutual funds as a way to help clients stay diversified. We carefully monitor the funds to make sure they are holding true to their stated investment philosophy. Each month we take an in depth look at our investment decisions and philosophy to be sure we are doing what we believe is in the best interest of our clients.
Thomas Gross, CFP®