When I talk to people about investing in stocks, the first response that I hear from people is that they are expensive and they don’t want to buy mutual funds. “Mutual funds? When did I even say anything about mutual funds?” It’s all good marketing of course. Like how Kleenex is associated with normal tissue paper, Coke is synonymous with regular cola, Q-tips are just regular cotton ear swabs, stocks go hand in hand with mutual funds. OK, OK, I know with the last 4 things I must have just blown your mind away. Let’s understand what the differences are.
First off let’s get some jargon down right. We’re in 2017 and I know acronyms are all the rage with FOMO and YOLO, but we in the personal finance side also have our own. When you hear the term “The Nice Lady At The Bank” we refer to her as TNL@TB. Yes. It’s a term. Go and Google it.
The TNL@TB is the seducer of your personal finances at the bank (this person can also be male BTW, totally not being sexist). That’s because she’s responsible for extracting as much profit from your hard earned money as possible. That’s what the bank is out there to do. Profit from your savings. Through the last few decades TNL@TB has been pushing mutual funds as way to save for retirement. These mutual funds are “like stocks”. There are professional managers that look after these mutual funds so you don’t have to. This let’s you can sleep sound at night. Not only that, TNL@TB only offers you what they consider to be “5 star” funds. These are funds where the manager has outperformed the market over the last couple of years. It all seems pretty good doesn’t it?
Then These Guys Came Along…
We’ve probably all seen that above commercial. A serious conversation with TNL@TB about retirement goals and the fees associated with running an investment portfolio. It seems that with the latest advertisements, the general public is now catching on to the scheme of high fees and the amount of money that is being siphoned away from investment portfolios over the decades. This had led most people to believe, buying “funds” is expensive. Owning stocks is expensive. The thought being brainwashed into the regular investor is that the only one making money are the bankers. The little guy is getting shafted again.
Like it or not, good marketing is very effective in subliminally getting us to believe things without a second thought. Being constantly bombarded by the same message over and over again is actually a very effective way in stimulating our brain to think a certain way. The message that investing in mutual funds is always expensive is the wrong message to send. It’s playing on the minds of the ignorant.
Basket Of Stocks
The first thing you have to realize about mutual funds is that they are actually just a basket of stocks. Pretend that you are going grocery shopping and you are walking around picking items off the shelf and putting it in your basket. The mutual fund is your basket. The stocks are all the individual items that you’ve put into your basket. These stocks don’t have to be the same. It’s exactly like the things that you’ve put into your shopping basket. It can be lettuce, ketchup, cereal, milk, donuts, etc… They actually don’t all have to be a alike. Your mutual fund can have banks, technology, health care, oil and gas. Every basket is different.
So who decides to put what into the basket? That’s easy, there’s always a manager for that basket. When you go grocery shopping, the manager of that basket is you. When you buy a mutual fund, the person who picks what stocks goes into the basket is the fund manager. Just like how your kids trust you to buy the right thing for their lunch tomorrow, you are trusting the the fund manager to buy stocks on your behalf for your retirement. How things end up into the basket is through research. When you buy groceries, your significant other or your kids are your advisors. They might want you to buy Cocoa Puffs and Twinkies, but the manager has the final say so you might get Bagels and Rice Crispies instead. The fund manager will hire advisors and researchers to help her decide but ultimately it’s up to the manager.
Of course every manager has their own style. You may choose to cook Indian, Chinese or Italian. So your grocery items will consist of items that fit your style. The things that end up in the basket are things that you are going to cook with. For a fund manager, she will also have her own style of investing. The way you determine how a fund manager will manage her investments is through the fund prospectus. The prospectus outlines everything about the mutual fund, not the stocks that are held within it. That’s a key fact to note. Mutual funds are a completely separate entity from stocks themselves. They are a product that you buy as a whole. When you buy a share in the mutual fund, you are essentially giving your money to the manager to do as she pleases using the style that you agree to. What the underlying stocks do on the other hand, is beyond the control of the fund manager.
Tying mutual funds to stocks is actually the wrong mindset to have. It’s like saying that all cola is Coke. If there’s a recall on Coke does it mean that Pepsi is bad as well? Should all other brands be subjected to the same detriment if one of them is bad. It’s like providing the blanket statement that my two year old is behaving poorly and therefore all 2 year old kids are bad. They’re all bad. Just give them away! See how preposterous that kind of statement is? It’s actually really ignorant.
The key thing to remember when someone talks about mutual funds is that it’s not a stock. Mutual funds can CONTAIN stocks and it is marketed as a product that is sold to an investor. The stocks that a mutual fund may hold can be completely different and can vary wildly from one another. What a mutual fund actually owns is determined by the fund manager. How the manager invests the money in the mutual fund is usually described in the prospectus which every investor should read before purchasing.
These are all the important facts to remember. Stocks are a completely different beast from mutual funds and in fact a mutual fund might not even hold any stocks at all. Mutual funds were created as a means to simplify investing for the average investor because it meant someone else would actively look after the money. That is how mutual funds are marketed. Understand these differences. So that when it comes time to shoot the water cooler talk, you’ll sound more like the investment banker, and your other colleagues will sound like the ignorant fools that were brainwashed by television.