valuation and selection. In addition to their necessary educational training, the best fund managers typically have a decade or more of experience in analyzing and selecting investments.
Consider the following activities that an investor should do before investing in stocks and bonds of their own choosing:
Analyze company financial statements: Companies whose securities trade in the financial markets are required to issue financial reports every three months detailing their revenue, expenses, profits and losses, and assets and liabilities. Unless you’re a numbers geek, own a financial calculator, and enjoy dissecting tedious corporate financial statements, this first task alone is reason enough to invest through a fund and leave the driving to the fund management team.
Talk with the muckety-mucks: Most fund managers log thousands of frequent-flier miles and hundreds of hours talking to the folks running the companies they’re invested in or are thinking about investing in. Because of the huge amounts of money they manage, large fund companies even get visits from company executives, who fly in to grovel at the fund managers’ feet.
Analyze company and competitor strategies: Corporate managers have an irritating tendency to talk up what a great job they’re doing. Some companies may look as if they’re making the right moves, but what if their products are soon to lag behind the competition’s? The best fund managers and their researchers take a skeptical view of what a company’s execs say — they read the fine print and conduct other investigative work. They also keep on top of what competitors are doing. Sometimes they discover investment ideas better than their original ones this way.
Talk with company customers, suppliers, competitors, and industry consultants: Another way fund managers find out whether a company’s public relations story is full of holes instead of reality is by speaking with the company’s customers, suppliers, competitors, and other industry experts. These people often have more balanced viewpoints and can be a great deal more open about the negatives. These folks are harder to find but can provide valuable information.
Attend trade shows and review industry literature: It’s truly amazing how specialized the world’s becoming. Do you really want to subscribe to business newsletters that track the latest happenings with ball bearing or catalytic converter technology? They’ll put you to sleep in a couple of pages. Unlike popular mass-market publications, they’ll also charge you an arm and a leg to subscribe.
Take a disciplined approach: Another thing great managers do is bring a strict discipline that clarifies what makes a stock attractive and when it no longer is and should be sold. Lack of discipline is shown by countless studies to be highly associated with poor results, because without a clear process, the tendency is for inexperienced investors to buy high when everything feels good and sell low when everyone is fearful. Discipline and process provides skilled managers with a clear framework to take advantage of good opportunities that others miss, such as during the inevitable swings between fear and greed.
A (BRIEF) HISTORY OF MUTUAL FUNDS
Mutual funds date back to the 1800s, when English and Scottish investment trusts sold shares to investors. Funds arrived in the United States in 1924. They were growing in assets until the late 1920s, when the Great Depression derailed the financial markets and the economy. Stock prices plunged and so did mutual funds that held stocks.
As was common in the stock market at that time, mutual funds were leveraging their investments — leveraging is a fancy way of saying that they put up only, for example, 25 cents on the dollar for investments they actually owned. The other 75 cents was borrowed. That’s why, when the stock market sank in 1929, some investors and fund shareholders got clobbered. They were losing money on their investments and on all the borrowed money. But, like the rest of the country, mutual funds, although bruised, pulled through this economic calamity.
The Securities Act of 1933 and the Investment Company Act of 1940 established ground rules and oversight of the fund industry by the Securities and Exchange Commission (SEC). Among other benefits, this landmark federal legislation required funds to register and have their materials be reviewed by the SEC before issuing or selling any fund shares to the public. Funds were required to disclose cost, risk, and other information in a uniform format through a legal document called a prospectus (see Chapter 8). Over the decades, the SEC has further beefed up required disclosures in prospectuses.
During the 1940s, ’50s, and ’60s, funds grew at a fairly high and constant rate. From less than $1 billion in assets in 1940, fund assets grew to more than $50 billion by the late 1960s — more than a 50-fold increase. Before the early 1970s, funds focused largely on investing in stocks. Since then, however, money market mutual funds and bond mutual funds have mushroomed. They now account for about 40 percent of all mutual fund assets.
Today, thousands of mutual funds manage about $27 trillion with exchange-traded funds holding another $7 trillion.
Are you, as the investor, going to do all these tasks and do them well? Nothing personal, but I doubt that you will. Even in the unlikely event that you could perform investment research as well as the best fund managers, don’t you value your time? A good fund management team happily performs all the required research for you, does it well, and does it for a fraction of what it costs you to do it haphazardly on your own.
Funds save you money and time
Chances are the last thing you want to do with your free time is research where to invest your savings. If you’re like some busy people, you’ve perhaps kept your money in a bank account just to avoid the hassles. Or maybe you turned your money over to some smooth-talking broker who sold you a high-commission investment that you still don’t understand but are convinced will make you rich.
Funds can produce a much better rate of return over the long haul than a dreary, boring bank or insurance company account. You can purchase them by writing a check, calling a toll-free number, or opening an account online and sending in money electronically. What does it cost to hire such high-powered talent to do all the dreadful research and analysis? A mere pittance if you select the right funds, which I help name in this book. In fact, when you invest your money in an efficiently managed fund, the cost should be less than it would be to trade individual securities on your own.
Funds manage money efficiently through effective use of technology. Innovations in information-management tools enable funds to monitor and manage billions of dollars from millions of investors at a very low cost. In general, moving around $5 billion in securities doesn’t cost them much more than moving $500 million. Larger investments just mean a few more zeros in the computer database.
Many funds don’t charge a commission (load) to purchase or redeem shares. Commission-free funds are called no-load funds. Such
