Understanding Mutual Funds
What is a mutual fund? The simple answer is that a mutual fund is a collection of stocks. Mutual Funds are managed by professional money managers that bring together a target grouping of stocks to take advantage of the synergies of a particular sector, without the risk of specific companies. So, a mutual fund may target the pharmaceutical segment and will rise or fall with industry trends, it will not swing based upon the fortunes of a particular stock. This is positive and negative. While you are at less risk of loss, you also do not benefit from high flying stock prices driven by single organizational success.
As an example, the Mutual Fund American Funds EuroPacific Gr A (AEPGX) is focused on companies that operate in the Pacific Rim. It’s top ten holdings, added together, do not account for more than 20% of the holdings of the fund. So, if you believe that conditions in the Pacific Rim are favorable for business, you can invest in this high growth stock without fearing that the Directors of Kookmin Bank will make poor decisions. If they do, 1.45% of your investment is impacted. However, if you believe that trade policy or as happened before, monetary policy decisions by governmental entities will impact business, you might want to steer clear of this particular mutual fund.
Another key decision criterion of any particular mutual fund is the expense ratio of a fund. Those money managers that move the fund between various companies and monitor the overall health of the fund, need to get paid. The expense ratio is how they do that. Compare the two funds below; one with an expense ratio of 0.81% and the other with an expense ratio of 0.55%. Now look at the performance. The five year annualized return of 16.14% slams the 8.58% return on the other. Is doubling your return worth doubling your expense ratio? I think so!
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