One Hour Investor by Vishal Reddy

Author:Vishal Reddy
Language: eng
Format: epub
Publisher: TCK Publishing
Published: 2020-01-08T10:58:59+00:00

CHAPTER 6:

Mutual Funds

You must be hungry by now, right? But you don’t feel like cooking, so you have a choice on where to eat out: either the local steakhouse or the local buffet. If you go to the steakhouse, the steak you buy may turn out to be the greatest one you’ve ever had or it could be the worst. But if you go to the buffet, you’ll have plenty of options to choose from. And if you place a dozen different buffet items on your plate, even if some of them aren’t that good, you’ll still be satisfied with your meal. The chances of you having a bad meal at a buffet are much lower than if you order one single steak at a restaurant.

In this example, eating the steak is like investing in a single stock. You’re putting all your eggs in one basket (or all your steak on one plate). If the steak isn’t good, then you’ve wasted your money. And hoping the steak will turn out well may be too risky considering all the money involved.

But at the buffet, you’re given a large enough variety of food so that no one food item dominates, and the majority of good items will make up for the minority of bad ones. Your overall buffet experience wasn’t ruined by any single item on its own. So, if eating at the steakhouse is like investing in a single stock, then eating at the buffet is like investing in a mutual fund.

A mutual fund is a type of investment vehicle that pools money from a large number of investors and invests it in a diversified portfolio on their behalf. Each investor owns a portion of the portfolio, depending on how much they have invested. The portfolio can include a mix of stocks, bonds, and other securities (or only stocks or only bonds, depending on the fund). Mutual funds are created with a specific investing objective in mind, like a “Mid-Cap Growth” fund or a “New Markets Income” fund. Fortunately, not only do mutual funds offer convenient diversification, but they are run by investment professionals from firms such as Vanguard and Fidelity. These professionals create the optimal fund that they believe will achieve the investment goals of their clients (actively managed funds) or offer a fund that replicates a stock index or bond index (passively managed funds or index funds).

Among the most popular types of mutual funds are those that reflect the stock market as a whole, such as the hypothetical Mutual Fund ABC below. This is an index fund, which is a type of mutual fund whose holdings reflect a specific index such as the S&P 500. This particular index fund is meant to reflect the entire domestic (American) equities market, and its holdings contain thousands of large, medium, and small stocks. This allows investors to have exposure to all these companies at once. As you can see in Figure 10, nearly all of Mutual Fund ABC’s holdings are of US stocks.

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