A breakdown of mutual funds, how professional management and diversification work, and why low-cost index funds tend to outperform actively managed ones over time. The speaker emphasizes long-term investing and notes this isn't financial advice.
All right, I promised you we're going to talk about mutual funds. What is a mutual fund? A mutual fund is just a bunch of investors pooling their money together to invest. And what do they get for doing that? Well, they get a few things. They get professional management, right? You're not going to be able to hire somebody for what you pay for management fees. You're not going to be able to hire an individual to just manage your money, right? Because it's practically free if you're investing in the right mutual funds. So you get professional management, you get economies of scale, right? You banded together with thousands or millions of other investors, so you get these economies of scale. You get better prices when you're going to buy things. You get diversification. There are rules. Mutual funds can't put all their money into one investment. A mutual fund cannot be the Tesla mutual fund and just invest in Tesla stock. You can't do that. It's required to not put more than a certain amount into any given stock or whatever the mutual fund invests in. And you got to have a certain number of investments in the fund, right? There's regulations on this stuff. So that's a benefit that diversification. As well as that regulation, you also get liquidity. You can sell this investment any day that the markets are open. In fact, if you buy an exchange traded fund, a type of mutual fund, you can sell it any minute the market is open, completely liquid. By the time it settles within a day or two, you've got cash. And so it's very liquid investment. It's easy to diversify, it's easy to build a portfolio. It's just a great way for people to invest, especially in the beginning. But as you can tell, I've been investing for 20 years and it's still the lion's share of my portfolio is in mutual funds. Now, there are two basic types of mutual funds. The first type is what's called an actively managed mutual fund. And in that type of a fund that professional manager is trying to. We'll use stocks as an example, right? Although mutual funds can invest in stocks or bonds or real estate investment trusts, or all kinds of different assets a mutual fund can invest in, we'll just pretend they're all in stocks at this point. But in an actively managed stock mutual fund, that prevents professional managers trying to pick the good stocks, the ones that are going to outperform the market and avoid the bad stocks. It turns out that's a really hard thing to do, especially after the cost of doing so and especially Especially after the tax cost to you of somebody trying to do so. So what's the alternative to active management? Well, passive management, AKA index funds. These are funds whose goal is not to beat the market, but to match the market. And beating the market is very difficult. In fact, you'll see long term numbers even before tax that only something like 10 to maybe as high as 20% of funds will beat the market over time. After tax, it's lower than that. And in some asset classes it's dramatically lower than that. But that's about what you see. But the truth is it's really easy to match the market. Simple. And you don't have to have an army of analysts going out and talking to all these people running companies, right? There's hardly any turnover in the fund. You just buy all the stocks in the index and that's it. It's pretty easy. And it's basically free, right? If you go to Fidelity, they have zero percent expense ratios. That's the percentage of the fund that's used for the fund's expenses every year. At iShares and Vanguard, a lot of these funds are 2 basis points, 3 basis points, 4 basis points, 7 basis points. That's basically 0.02% per year or 0.07% per year. It's nothing. It's free. It's free compared to paying for anything else in financial services. And so it's a pretty awesome benefit that you can own all of the stocks in the world essentially for free. These are the most profitable companies in the history of the world. In the last two or three plus millennia. These companies make more money than any other companies ever founded. And you can be an owner of those Companies all in 30 seconds just by going to Vanguard or your favorite brokerage and buying the nice shares. Or a Vanguard or Schwab ETF that invests in these companies. So it's a pretty powerful way to invest. Just keep buying. You know, stocks go up, stocks go down. Just keep buying. Keep your expenses low. And you'll be amazed what a mutual fund portfolio can grow to over time.
The hosts of the White Coat Investor are not licensed accountants, attorneys or financial advisors. This podcast is for your entertainment and information only. It should not be considered professional or personalized financial advice. You should consult the appropriate professional for specific advice relating to your situation.
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