A Tycoon Of The MUTUAL FUNDS
Winston Smythe Kennsington III -- our second-estate financial maestro -- has given me a hot, and I mean REALLY HOT, investment tip. Waldo Industries, the parent company of Waldo's TexMex Taco World, is making plans to expand its franchises. Marketing studies show that people are ripe and ready for Waldo's Super Deluxe TexMex Gargantuan Tacos beyond the confines of Shady Valley. For a minimal investment, I can grab a share of this money-making opportunity. A minimal investment to our Ivy-League friend Winnie is $500,000. Unfortunately my bank account, including recent deposits of loose change found on our pedestrian trek, is a few zeros short. Is this another sure-fire financial opportunity that will pass me by?
Money Begets Money
It seems as though the only way to make a gadzillion dollars by investing in financial markets, including the likes of the stock market, is to start with a gadzillion. Card-carrying members of the third estate, with limited financial assets, find it difficult to play the game like Winston Smythe Kennsington III and his second-estate gadzillionaire cohorts.
It's an unfortunate fact of life that Winnie and his second-estate cohorts can make their gadzillions grow like mold on month old bread. Most members of the third estate, without gadzillions, don't quite have the same chance. Here a few notable reasons why:
- Information. Risk and uncertainty are the hallmarks of the financial markets. But, as we saw in Fact 6, Our Unknown Economy, the information needed to reduce risk and uncertainty is costly to get. The greater your wealth, the more information you can have at your disposal. The second estate employs many financial advisors who spend their entire lives searching for the best ways to turn one gadzillion dollars into two gadzillion dollars.
- Transactions Costs. Moving your investments through the maze of financial markets, buying here and selling there, rings up brokerage fees, telephone expenses, and assorted costs. Those costs, however, are much smaller relative to a $10 gadzillion investment than a $137.65 investment. Relatively less is eaten up by transactions costs if gadzillions are invested.
- Diversify. Risk and uncertainty also make diversification a wise investment technique. It's much easier to diversify into dozens of different investments with $10 gadzillion than it is with $137.65. Some investments, like Winnie's tip on Waldo Industries, need a minimum "entry fee" so to speak. You can't diversify if you have enough for only one investment.
Enter Mutual Funds
While the second estate might dominate in terms of total dollars in the financial markets of our economy, the third estate actively participants. The primary function of financial markets is to match up lenders with borrowers. In many cases, the lenders are members of the third estate with a few bucks and the borrowers are the businesses of the second estate aiming toward investment.
Banks and insurance companies, play a big part in accumulating funds from the third estate and making them available to second estate. However, they're somewhat limited in how they use the third estate's accumulated funds. For example, banks don't fiddle around in the stock market.
Wouldn't it be great if the members of the third estate, even though we might not have gadzillions to invest, could gain direct access to some of the highest-return financial markets? Wouldn't it be nice if I could somehow get in on Winnie's hot tip on Waldo Industries even though I don't have a big initial investment? Here's a thought. If I teamed up with a couple of hundred other pedestrians, then together we might have enough for Winnie's money-making investment.
This is, in essence, the objective of mutual funds. They give investors with small bank accounts the opportunity to participant in various financial markets that would be out of reach otherwise.
A mutual fund works like this: A mutual fund company administers the combined investment dollars accumulated from thousands of consumers. Because the mutual fund has gadzillions to invest, rather than mere thousands, it operates just like any really wealthy member of the second estate -- better information, lower transactions costs, and a great deal of diversification. In that a mutual fund provides fewer services than banks, it also has fewer expenses. The end result is that investors get higher returns.
All Sorts of Mutual Funds
As most daily newspapers show, there are hundreds of mutual funds offered by a multitude of different mutual fund companies. What the newspaper doesn't show is that different mutual funds usually pursue different objectives. If you're contemplating the mutual fund route with any of your spare change, you need to get a good handle on these objectives. A few of the common ones are:
- Liquidity. Several sorts of mutual funds put their funds into so-called money markets, which deal in short-term Treasury bills, commercial paper and the like. These act much like savings accounts (but pay a higher interest rate) with the goal of keeping funds liquid, or easily transferred into other funds.
- Bonds. A popular investment of mutual funds is the wide assortment of long-term corporate bonds, Treasury bonds, and municipal bonds. Some of these funds, especially those for municipal bonds, can provide tax-free interest. However, be sure to read all of the fine print to see if you qualify.
- Growth. These search out stocks that are most likely to experience a rapid price increase. The basic philosophy here is to buy low and sell high. Of course, this tends to be very risky because it seeks out the short-run ups and downs of the financial markets. Be careful with these.
- Income. These funds relay primarily on quarterly or annual dividends or returns paid on stocks and/or bonds. The goal here is more long term, secure investments that prosper along with the long-term growth of the economy.
- Growth and Income. These funds seek balance the risk of high-growth stocks with the returns from more secure, long-term growth of stocks and bonds. They're not a bad sort of general mutual fund investment.
- Commodities. Some mutual funds invest exclusively in gold, silver, farm products, or other commodities. As such, they perform right along with these commodities, which means you can stand to gain or lose a lot.
- International. A number of mutual funds buy nothing but stocks and/or bonds from another country or group of countries. These funds gain or lose with the growth or decline of the country or countries. The exchange rate is also important for these funds (see EXCHANGE RATE).
- Selected Industries. Many mutual funds invest exclusively in the stock of a particular industry, such as health care or telecommunications. A fund's performance is tied directly to the profitability of the underlying industry.
Tips for the Mutual Fund Tycoon
- Some mutual funds are better than others. In addition to differences in what the funds try to do, there are differences in how well they do it. Some pay high returns and have low administrative costs, and others don't.
- Several consumer and business publications provide annual mutual fund evaluations. Check them out before jumping into the mutual fund ballgame. It's worth the effort to do a little research before investing.
- Every mutual fund, by law, provides a prospectus to potential investors that outlines, in some detail, the goals, structure, fees, and types of investments of the fund. This is something that you want to read carefully before investing.
- Overall, mutual funds are a viable investment and saving option for anyone without a lot of extra money. Many funds require no more than a few hundred dollars to open.