How Do Mutual Funds Work?

Jennifer asks how mutual funds work. She doesn't have a clue and wants to know before she starts investing.

QUESTION: Jennifer on Facebook asks how mutual funds work. She doesn’t have a clue and wants to know before she starts investing.

ANSWER: I would sit down with a good mutual fund broker to help you understand that. Get with someone who has the heart of a teacher.

A mutual fund—if it’s a stock mutual fund—is a group of 90–200 stocks. If it’s a growth stock mutual fund, it’s a group of 90–200 growth stocks. Stock analysts pick the companies that they think are going to go up in price, and they sell the companies out of the fund that are going to go down in price. You put money in, I put money in, others put money in, lots of people put money in, so it’s mutually funded. Then they buy growth stocks, so that makes it a growth stock mutual fund. If they’re buying bonds, it’s a bond mutual fund.

It is much safer than a single stock investment because your $1,000 or $10,000 or $100,000 or whatever is spread across 90–200 stocks, and you’ve got people smarter than you picking the stocks.

You can tell how the fund has done by looking at its track record over a long period of time. Don’t buy new funds. Buy a mutual fund that’s been out there for 10 years, 20 years, that kind of thing. I’ve got one that’s been open since 1934, as an example. I like looking at that long track record. That gives me confidence that over time they’re going to be all right.