While the exact date of the first mutual fund is not exactly agreed upon, the basic concept of mutual funds dates back to the 1800s. By the early 1900s there were hundreds of mutual funds in existence leading to the creation of the Securities and Exchange Commission and several acts including the: Securities Act of 1933, Securities Exchange Act of 1934, and the Investment Company Act of 1940. These laws and regulation were put in place largely to protect investors. As of 2018 there were more than 9,500 mutual funds listed in the US.

So, what is a mutual fund?

In its most basic definition a mutual fund is an investment vehicle that pools investors’ money together to build a portfolio of securities. Mutual funds can offer the benefits of diversification and professional management to virtually all investor types. The underlying investments in mutual funds often consist of stocks and bonds, but may contain many other types of investments such as real estate, commodities, and currencies. Every mutual fund is required to have a prospectus which must clearly define its investment objective which can help a potential investor in the selection process. Through the use of a mutual fund the often times complex duty of selecting and trading individual investments such as stocks, bonds, or other securities is passed along to the fund manager rather than the investor themselves.  

The trading (buying or selling) of mutual funds is different than trading stocks. The price of a mutual fund does not fluctuate intraday like the individual stocks that you see scrolling on the financial news channels. Orders placed during the day will be priced based on the end-of-day net asset value (NAV) of the fund. At the most simplistic level the NAV is calculated based on the total value of the securities held by the fund divided by the number of shares of the fund.

A hot topic in the last few years has been the fees and expenses associated with investment vehicles, a discussion often directed at mutual funds simply due to their prevalence. The expense ratio is the most commonly known fee associated with a mutual fund, the fee can range anywhere from a fraction of a percent on the low end and upwards of 2 to 3 percent on the high end. The fund’s investment universe (the investing parameters for a managed fund), and the management itself typically determines the expense ratio. For example, funds investing in asset classes requiring more effort to gather data and information in order to select securities, such as small capitalization and international mutual funds, tend to have higher operating expenses compared to large capitalization mutual funds. The performance that an investor experiences is net of the expense ratio. Important to note, fees may or may not be overcome by the return of a fund. The attention on costs has increased competition leading to lower fees and more available options; both of which have been a net positive for end investors.

While there are many mutual fund evaluation metrics to consider, performance is an accessible starting point. Some other important ones are manager tenure, management team, turnover, measures of risk, taxation, investment style and style drift. Of course, one of the most common disclaimers, “past performance is not indicative of future results” is very applicable when evaluating funds. Performance should be viewed in relation to the objective of the fund, relative to other holdings in the portfolio, and the objective of the investor.

In summary:

1. Mutual funds, in one form or another have been around for over 100 years.

2. Mutual funds can provide investors with portfolio diversification and access to professional management.

3. Fees have been declining to the benefit of investors.

4. When evaluating a mutual fund, performance is important to review but is just one data point.

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Source Data: S&P Dow Jones Indices SPIVA® U.S. Scorecard Year-End 2018