Investing 101

Historically the stock market was closed to anyone other than the relatively wealthy. In 1970, a $2000 stock purchase carried $150 commission. In order for an individual to buy a diversified basket of stocks, meaning 20 to 40, they would need several hundred thousand dollars and they would have paid usurous commission rates. Then along came the mutual fund industry. Mutual funds aggregated demand for shares which professional packaged so that the common man with a whopping thousand dollars of savings could be exposed to 20 to 40 different stocks and not have to pay crazy commission rates because those rates would have been negotiated by scale professional buyers. The mutual fund industry democratized stock market participation for the common man and it was a great industry for several decades. In addition to allowing an individual to purchase a range of stocks inexpensively the mutual fund industry offered professional stock selection which, during an era of poor information dissemination from companies and brokerages, was a sizable advantage for the professionals.

Then came the electronic revolution. Computers, cheap telephony and legal changes turned the industry into a hybrid commodity. Very little difference could be determined from any one set of managers with another. In addition to relatively high fees of 1% plus per year, plus brokerage commission loads for small sized buyers, and negative tax consequences for trading in stocks (gains recognized and taxed) on after fee, after tax basis, mutual fund performance came to pale against index funds for most funds.

The winner at the end of the mutual fund rainbow was index funds which simply buy a basket of stocks exposed to a sector or a broad index like the SYP 500 and those funds almost never trade. Instead of 1% per year fees, they charge very small. Because they almost never trade they recognize almost no gains for tax purposes and simply compound at a rate equivalent to the stock market.

You are not a professional. Don’t try this at home. If you want to be a professional, go to college, business school, be good at math and get a job and know that of all the professional who do this only about 2% outperform the market.

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