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principles of finance a la shmoop drill down on mutual funds all right

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yeah that's what we're doing here people mutual mutual funds mutual as in

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together with a collective purpose like the members of the mutual admiration [two people admiring each other]

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society you have those guys all right well in the finance sense lots of little

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gal and guy investors getting together hiring a professional money manager set

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lawyers accountants and others all with the collective goal of having their

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capital appreciate in value they're mutually aligned or they could be [pile of money with googly-eyes]

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mutually aligned having dividend thrown off in buckets or having a safe preserve

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of wealth or else some collection of all the above the goals are all mutual and

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with cash contributed from everyone in this financial Stone Soup they have

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created a fund and while most funds have a goal they are generally diversified

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albeit sometimes inside of a sector think an energy fund a transport fund a [wind turbines, trains, electric wires]

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telecommunications technology fund while sector funds are technically mutual

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funds well they aren't really diversified and diversifying risk here

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is a key element of the mutual fund promise being diversified in tech is

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dandy but if that's all you own while you have massive exposure to the tech

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sector and if that tanks well so do you yeah in tech it thanks a lot mutual

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funds in general is the broad ones offer investors a much more effective way to

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diversify their investment holdings and take advantage of the liquidity that a

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bunch of people coming together to invest offers they can invest in a broad

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range of categories that generally align with the manner in which the S&P 500 is

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divided like and well let's check this out so where do you put your hard-earned

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savings energy utilities transports bonds stocks tea bills yeah this thing [pie chart]

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no not that thing instead of figuring out for yourself what to invest and you

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let the experts do it for you at least that's the theory it doesn't always work [woman writes on blackboard]

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out that way at least how it was planned on the blackboard because sadly most of

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the time well in fact almost all the time the experts are wrong and you do

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better off owning an index fund than actually giving your money to a mutual

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fund but a little bit of a different story at

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least for now mechanically a mutual fund is just an investment company you invest [writing on white board]

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by purchasing shares in that investment company and we promise we'll get into

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how those shares are priced in a little bit your money and the money from all

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the other investors is pooled and then invested by an investment manager and

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there are many different investment strategies that mutual funds can adopt

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and that the manager will make as they make their investments that are

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appropriate for that funds strategy well in return for the investment acumen or

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alpha the managers of that fund receive a fee which is calculated usually as a

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percentage of the funds it manages like think one percent of the assets under

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management or there abouts well mutual funds are governed by the Investment

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Company Act of 1940 not active IDEs these investment companies into three

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broad categories management investment companies a fancy name for mutual fund

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unit investment trusts and face amount certificate companies well the forty Act

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sets out a boatload of rules governing mutual funds but one of the most [man on ship with barrels of rules]

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important that you need to know is that to be classified as an investment [writing on white board]

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company that company has to distribute all income and all gains and losses to

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its shareholders in other words it acts as a pass-through for the investors

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benefit like they can't just hoard all the cash keep it and say neener neener

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so let's take a look at a few types of funds starting with domestic equity

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funds well these are stock funds which have a blend of maybe small cap mid cap

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and large cap companies in their portfolio with a bias toward growth or

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value or a balanced or mixed or blended approach domestic equity funds also

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include the various specialties like real estate utilities healthcare [nurse wheeling patient]

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commodities Natural Resources technology insurance and banking and so on well

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those funds would be targeted or non diversified funds if they generally held

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only stocks of companies in that one specific category well what about

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international stock funds yep same as domestic funds like domestic funds only

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investors generally in us-based companies meaning they're based here but [map of USA with domestic funds getting distributed]

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they probably sell their product all over the world there are country

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specific funds and funds that can invest in any international company regardless

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of where it's in Corp rated you might see a reference to a

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global fund the difference between a Global Fund and an international fund is

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that while global funds invest here international funds generally don't a

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u.s. global fund can invest in Exxon but a u.s. international fund well maybe

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can't because Exxon is a domestic company all right moving on that's

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enough on stocks and also good bonds we're being very broad here we know this

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is just an overview video it's just well a bunch of bonds but bonds generally [writing on whiteboard]

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don't include municipal bonds because that's kind of a different category of

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bonds because they are tax sheltered meaning there are no tax so generally

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muni bonds or for people who pay very high marginal tax rates if you pay low [people paying taxes]

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tax rates you'd have no reason to buy immunities so they kind of get

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categorized separately well bond funds come in myriad flavors from junk and a

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very risky bonds all the way back here to US government issues and generally

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very very safe and boring the key distinguishing factors in bond funds are

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largely duration that is short medium and long term bond funds the longer the

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term of the bond the more exposure there is to credit cycles of the world and to

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inflation so longer-term bond funds are generally much more volatile than

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short-term ones but the interest rates and longer term bonds are often higher

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as certainly in a world where the yield curve is normal making up for that

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disparity in the different rates at least to some extent

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well what about muni bond funds well their bond funds that only invest in

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muni bonds which means they're tax sheltered and not tax-free bonds and you

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know the end there for the high earners and good for them all right moving on [women clinking wine glasses]

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next up is a classic money market fund well mm F's are actually a huge category [writing on white board]

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but they're just bond funds with very short-term durations and in theory very

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low levels of risk as well usually they're sold no load money market funds [man jumps of diving board into pool]

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are strategically important to mutual funds as a business because customers

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like to use them as a jumping off or jumping on vehicle when they make a

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commitment to a mutual fund like they wire in the cash through the money

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market front it sits there awhile while they're shopping for the specific mutual

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fund they want to buy and then they just transfer the dough got it and when you

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think about it well for mutual funds mm F's are a kind of airport for the [money man running around in airport]

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- wanting to be spent on tourism alright next balanced funds yes he were gonna do

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a mashup here of bonds and stocks well there are thousands of mixes that is one [woman mixing ingredients in bowl]

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fund ISM a B 30 percent u.s. domestic equities and seventy percent u.s.

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domestic bonds others have blends of international equity and bonds and

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domestic stocks and bonds and so on and the ratios are just all over the place

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and they try to balance on some fulcrum that their marketing literature defines

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but they're all mutual funds and they all have their own particular set of

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strictures all right moving on finally let's talk about mutual fund [writing on white board]

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diversification all right this is the seventy five five ten rule the

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Investment Company Act of 1940 has a whole bunch of rules which define what

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mutual funds are and are not and they set guidelines as to how they can behave

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and structure themselves well a diversified fund means that the fund is

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exposed to many areas like energy telecommunications the consumer banks

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technology and so on in theory a diversified fund is less volatile than a

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non diversified fund for a fun to qualify to be able to advertise itself

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as being diversified which old people here as well that's a lot less risk than [old man on screen]

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right well seventy five percent of its investment capital must be in no more

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than five percent positions in any one security like it can't be too

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concentrated into one thing and yes you might ask well what if it was half in

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Amazon for a last decade or two yes that would be good but that would have not [pie chart]

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been diversified and followed the 1940 rules it also can't own more than ten

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percent of any one company's outstanding shares why would that be a rule in this

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seventy five ten thing if the company ever needs to sell those shares and be

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liquid goes big redemption of mutual fund shares and they need the cash to

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give exiting investors their cash well ten percent position is probably

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illiquid they need a whole big haircut then to get there right but note that

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for twenty five percent of the portfolio the fund can quote violate unquote these man with diversified fund bag for a head]

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diversification rules tagged under the 75 percent umbrella right so there's

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some wiggle room like if a portfolio manager wants to

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take a huge bet on something dot-com thinking it's gonna go up a whole lot

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and move the fund well they can do that well a common test question that you'll

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get if you ever get tested on this stuff relates to the

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maximum that a fund can own of one security and still call itself

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diversified and the answer is usually thirty percent not twenty five a non

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diversified fund is one that fails that seventy five five ten tests that works

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there it's everything else which may be misleadingly narrow as many technically

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non-diversified funds are actually highly diversified but because a bunch

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of narrow do Wells messed with our system so heavily in the roaring 20s [party in the dark]

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well rules have to be created and policed with rigor so yeah that's an

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overview of mutual funds we'll have a whole lot more about this for you now

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feel free to join the I don't know new the shmoop mutual fund admiration

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society is that a thing [mutual fund joins mutual admiration society]

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