Much like death and taxes, there are some things in life that simply remain unavoidable. In the recent quarters’ economic slowdown and now volatile daily gyrations of the stock market, many novice and experienced investors often times incorrectly believe that investments in mutual funds remain one of the safest alternatives to the preservation and growth of investment capital. However, even today many investors fail to appreciate that some mutual funds have also suffered from some of life’s unavoidable pitfalls.
In the strictest interpretation, mutual funds are defined as a company or "investment instrument without fixed capitalization that sells its own shares and uses the pooled capital of its shareholders to invest in a variety of securities of other companies." Many investment advisors, however, describe mutual funds to their novice clients as simply a "basket of money from literally thousands of investors that is used to buy into a broad number of different company’s securities." In fact, mutual funds have long been touted as being the lesser risk type of investment for clients because mutual funds generally invest the mutually pooled capital of investors into several hundred differing companies. The beauty of mutual fund investing has long been that it affords investors the unique opportunity to spread their risk over a wide number of diverse companies and industries as well. Clients are often advised that they will be buying shares of household companies that that they are familiar with and know have been around for a long time – Coca Cola, IBM and General Electric, for example.
Over the long haul, the diversity of companies that mutual funds invest in, pharmaceuticals, banking, biotech, insurance, real estate, and other sectors, allows investors to also reap the financial rewards of these differing companies and sectors as they are well established in the global marketplace. For example, some mutual funds might be touting their "Blue Chip" (large established multinational corporations) holdings of Microsoft and Motorola while simultaneously investing in small-unknown biotech firms that are developing new cancer medications. The benefits of mutual fund investing by many of the investing public have long been seen as "not putting all my eggs in one basket." On the surface, mutual funds then would seem to be a prudent, conservative investment vehicle for the average unsophisticated investor who might initially be skeptical of putting money into the stock market. With the heinous financial scandals still percolating in the marketplace about Enron, for example, where employees were encouraged to invest heavily in Enron stock, mutual funds would, by definition, appear to offer investors an almost unavoidable, risk depreciated alternative. As investors around the world have sought alternatives to buying company stock outright in today’s volatile markets, many are increasingly adding mutual funds to their portfolios.
Before investing in any of these products, an individual should discuss with their financial consultant the investment techniques employed by the fund managers of the plethora of funds, enabling the investor to select those funds with strategies which are most suitable for his or her investment style, risk tolerance, investment goals, returns sought by the investor, and many other issues including downside volatility. The reason for this is that according to Weisberger Thomson, a Maryland financial services firm, a record 223 mutual funds went belly-up in 2000. Most industry representatives do not like to talk about this startling fact, but the mutual fund market is highly competitive and all investors should be apprised of how mutual funds make (or lose) money for themselves. The costs to operate a mutual fund have increased to the point where funds typically do not become profitable until they reach the $50 million mark. Additionally, funds that have at least a five-year track record should be a real consideration for the investing public; when a mutual fund closes shop and liquidates whatever may or may not be left, shareholders are not only hit with the startling reality of declining net proceeds but the tax implications as well. Therefore it is important for all investors to take this time to learn from the current carnage on Wall Street.
A regular revisit of the underlying holdings in one’s portfolio will clearly ensure that your investments remain well protected from some of the common pitfalls that have resulted in the inevitable liquidation of an investment vehicle that many investors believe to be fail safe.
Robert I. Harper is an Ivy League graduate and frequent on-air financial advisor with MSNBC. A former investment-banking Associate with Goldman Sachs & Co. he can be reached at by email at Robertiharper@aol.com or (201) 333-2005.