Investment Funds

Investment Funds

What are investment funds?
The term “investment fund” is synonymous with “mutual fund.” People use the terms interchangeably, but they are talking about the same thing.
So what is an investment fund and why are they so popular? They are typically a fund that purchases securities and is managed by a professional. Each fund has an approach to investing, whether it’s an equity fund that invests in stocks, a balanced fund that invests in both stocks and bonds, an income fund that invests in bonds and other income-producing instruments, or a money market fund that acts more like a savings account by investing in short-term debt instruments.
And within each of these approaches, there are even more ways to customize the goals of your fund. Some will have a growth orientation, meaning they are interested in maximizing the growth of the net asset value of the stock; others will have a value orientation, meaning they are looking to purchase stock in companies that are undervalued and then hope to watch the market realize the company’s value; still others are looking to return a fixed and steady stream of income and so they will invest in bonds or other government issues that have a guaranteed rate of return. In addition, there are funds that will try to mimic a market index – these are called index funds; and there are specialty funds that invest in certain market sectors, such as international funds, technology funds, healthcare funds, regional funds, etc.
At last count, there were over 10,000 mutual funds available to US investors! So this is one of the reasons why investment funds can sometimes be confusing. The amount of information can be overwhelming. But don’t worry, because I’m here to simplify things for you.

Why are investment funds so popular?
Investment funds provide the average investor a way to benefit from the expertise of a professional money manager, without paying exorbitant fees. Decades ago, the only way you could get professional advice about how to invest was by hiring a money manager to handle your investments. Not only was this expensive (so most people couldn’t afford it), but you also had to have a sizeable portfolio to invest. But then investment firms introduced mutual funds, which allowed investors with $1000 or more to invest their money and have it be managed by a professional.
These fund managers have specific goals, based on the type of fund they are managing. So it’s very important that you understand the type of investment fund and its specific goals before you invest.
Who are some of the reputable companies offering investment funds?
While there are hundreds of mutual fund companies out there, there is a reason why three mutual fund companies have the bulk of the market. The top three companies are large firms, with combined assets in the trillions! – so they must be doing something right. Because of their size, they are able to keep their costs down and to weather market conditions better than smaller companies can. The three largest investment fund companies are: The Vanguard Group, American Funds Investment Company, and Fidelity Investments, in that order. I’ll recommend the company I think is the best choice a bit later in this article, but first, let’s take a look at the type of investment fund I recommend.
What type of investment fund do you recommend? I mentioned several different types of investment funds, and each one has its pros and cons, risks and rewards. Typically, the higher the potential return, the higher the risk. And no investment fund is totally devoid of risk.
One of the easiest ways to invest is through index funds. Index funds are not actively managed by human beings, but instead are set up by a portfolio manager to track the returns of a specific market benchmark, like the S&P; 500 Index. An index fund does this by holding the same securities or a representative sample of the securities in the index it’s tracking.
The goal of an index fund is to perform the same as or better than that index (if the portfolio manager has selected the investments wisely). Index funds are much less expensive to operate than actively-managed funds, so they will generally have lower expense ratios; yet they still have the potential to outperform the market. Another benefit of index funds is that they typically have lower taxable distributions than active funds do.
What are the risks?
There are risks involved with index funds, just as there are with any investment. There are no guarantees, so a market decline in the benchmark that the index fund is following will lead to losses for the fund as well. For example, if you invested in an S&P; 500 Index fund and the S&P; 500 Index drops 20%, it is to be expected that your index fund will experience the same drop in value (since it is modeled after the S&P; 500 Index).
Another risk is that the portfolio manager may not meet the goal of closely tracking the benchmark, or the manager’s selection of securities could underperform the benchmark, or the market could have overall losses that affect your fund.
How should I allocate my assets?
I recommend you use asset allocation to invest in several index funds so that you diversify your investments in uncorrelated securities. A good start might be to invest in a total stock market index fund, a small cap value index fund, a total international stock index fund, and a total bond market index fund.

And while this will give your portfolio some level of asset allocation, you can refine it even further if you’d like. To do this, look at what securities each of your selected index funds holds and see if there are significant overlaps in the types of securities. A good place to start is with the international stock index fund and the total stock market index fund: if you see that both funds are investing in the same types of securities (meaning they are correlated and will most likely rise and fall in response to the same events), then you may want to either invest in just one of the two index funds or find two index funds that are not as highly correlated.
What company do you recommend for index fund investing?
One company in particular stands out in this field, and that is Vanguard Investments. On average, their index funds cost about one-fifth the industry average for index funds. Believe it or not, that difference in expenses will have a big impact on your returns over time! (Note: I do not receive any remuneration from Vanguard – I recommend them because they are a reputable company, have excellent customer service and the lowest expenses.)
Do expense ratios really matter?
There are one or two other low-cost index funds available, but Vanguard also offers top-notch customer service and great end-of-year reports, so that’s why I like them. But just to show you how big a difference there is in expense ratios, even among index funds, here’s a comparison between Vanguard and Morgan Stanley – looking at each of their S&P; 500 Index funds:

Industry average for all S&P; 500 Index funds = .38Vanguard’s S&P; 500 Index Fund = .18Morgan Stanley’s S&P; 500 Index Fund = .58 to 1.34 ( and 1% deferred load to 5.5% front load depending on class)
The big difference in the expense ratios will also create a significant difference in your overall returns. Assuming you invested $10,000 in each of Vanguard and Morgan Stanley’s S&P; 500 Index funds and left it there for ten years while reinvesting all dividends and capital gains, this is what your returns would look like:
Vanguard Index 500 $22,303.12 Morgan Stanley $21,031.93 (average of three classes)
Source: “Anatomy of a rip-off: Morgan Stanley S&P; 500 Index Fund, 5/28/08”
This example shows that you would have paid $1,271.19 MORE for the privilege of investing with Morgan Stanley – and remember that this is an index fund, so it’s not actively managed!
Summing it up
So now you know that investment funds and mutual funds are the same thing, and that while there are hundreds of companies offering investment funds, your best bet is to go with one of the industry leaders; and that I wholeheartedly recommend Vanguard. You also know that while there are a myriad of different types of investment funds available, the easiest way to invest is by diversifying with several index funds that are not correlated.