“No issuer of securities is subject to
more detailed regulation than mutual funds.”

– Ray Garrett Jr.,
former chairman of the
Securities and Exchange Commission

The concept of mutual funds originated in England. British and Scottish investment companies (or trusts, as they were known) helped finance the American economy after the Civil War. They did so by investing in farm mortgages, railroads, and other industrial companies.

The first modern, open-end investment company (mutual fund) was Massachusetts Investors Trust founded in 1924 (it is still operating today). Many other funds followed until the stock market crash of 1929. Many of these first funds were highly leveraged and when the market crashed – they crashed hard. According to the Securites and Exchange Commission (SEC), the average dollar invested in these leveraged funds in July of 1929 was worth only $.05 by the end of 1937.

Because of the abuses that occurred in the stock market during the 1920s, several major legislative acts were enacted. Among them were the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Advisers Act of 1940, and the Investment Company Act of 1940. In addition to the federal statutes, most states have adopted their own regulations governing mutual funds.

These laws require, among other things, that a mutual fund be registered with the SEC and meet certain operating standards. Also, mutual funds must provide potential investors with a current prospectus. The prospectus must contain information regarding the fund’s management, its investment objectives and policies, fees and other information. The laws also limit what a mutual fund can state in its advertisements. These laws, as well as more recently enacted legislation, serve to protect the individual investor.

The various laws also dictate how a mutual fund is structured:

There must be a custodian whose functions include safeguarding the fund’s assets. The custodian, which is usually a bank, will provide payment when securities are bought and receives payment when securities are sold.

The transfer agent, which may or may not be the same institution as the custodian, administers shareholders’ account records, i.e., issues new shares, cancels redeemed shares, and distributes dividends and capital gains to the shareholders.

The investment adviser, which is usually the same as the management company, is in charge of the fund’s portfolio. The investment adviser makes the buy and sell decisions of the fund and is usually paid based on a percentage of the fund’s assets. The average fee is one half of one percent annually.

In 1940, there were 68 mutual funds with combined net assets of almost 450 million dollars. By 1970, the figures increased to 361 mutual funds with net assets of over 47 billion dollars. By the end of 1994, there were over 95 million accounts in over 6,000 different mutual funds with 2.1 trillion dollars in assets. And by 2004, there were over 8.1 trillion dollars in assets in more than 8,300 U.S.-based mutual funds!

What has accounted for this tremendous growth in mutual funds? One reason was the introduction, in the early 1970s, of the money market fund. The money market mutual fund allowed the small investor, for the first time, to receive the relatively high, short-term interest rates offered by the money market that was previously available only to institutions and wealthy individuals. 30% of all mutual fund investors got their start in mutual funds with a money market fund.

A second reason is the dramatic growth in the number of funds available. Since 1970 there has been an increase of almost 8,000 funds – a total of more than 8,300 at the end of 2004. These funds offer an investment objective to meet virtually any investor’s needs.

Another reason is the popularity of using mutual funds for retirement assets. By the end of 2004, mutual funds accounted for $3.1 trillion – or 24 percent – of the $12.9 trillion U.S. retirement market. Nearly two-thirds of households which have IRAs include mutual funds in their IRAs.

In 2004, 92 million individuals in 54 million U.S. households (almost half of all U.S. households) owned mutual funds. This is up from just 6% in 1980.

The median age of mutual fund shareholders is 48. 71% are married and more than half (56%) are college graduates. Their median household income is $68,700. They have financial assets of $125,000 (excluding real estate) with mutual fund shares accounting for 47% of these assets. 70% bought their first mutual fund more than 10 years ago. The median number of funds owned is 4.

Because of their growth and popularity, mutual funds have become the nation’s second largest type of financial institution – behind only commercial banks.

In History of Mutual Funds, we have given a brief history of mutual funds and who invests in them.

In Advantages of Mutual Funds we discuss the many advantages mutual funds offer the individual investor including diversification, professional management, low cost, ease of recordkeeping, dollar-cost-averaging, liquidity, family of funds, and convenience.