Finance: What Are Mutual Funds?

What are mutual funds? Mutual funds are an aggregation of stocks, professionally managed for a "small" fee. Investors wanting exposure to a given area can buy mutual funds focused on dividend or interest payments. They can focus on growth and tech. Or internationally. Stocks, bonds, commodities, and other vehicles all comprise mutual funds.

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Transcript

00:29

volume or bulk right? well if not check these guys out

00:33

84 pounds of dog food for five bucks. even Fido can appreciate a good deal

00:37

when he sees it. dog food discounts we get but why would

00:40

anyone need to buy in bulk when investing in stocks and bonds?

00:44

well because back in the day the only way investors could invest in the stock

00:48

market was to buy an individual stock directly. same deal with a bond. a

00:53

typical stock might sell for 40 bucks a share. the problem was that if an

00:57

investor didn't buy a round lot of these shares while she was charged a massive

01:02

Commission. almost like a penalty for not being rich enough to buy a Costco type

01:07

portion of shares. well a round lot is any order that comes in blocks of a

01:11

hundred shares. ie 200 shares is a round lot, 500 shares is a round lot 738 shares

01:18

is not a round lot. some high-level calculus there. well the typical round

01:22

lot Commission might be 5%. an odd lot Commission might be 15%. so it made it

01:29

even harder for the small buyer to get invested in the market.

01:37

on a purchase of 100 shares at 40 bucks that's four grand. that's even a lot of

01:41

money today but think about what four grand bought you in 1952. but more than a [calculator showing inflation]

01:47

few hula hoops and a poodle skirt. inflation-adjusted it's almost 40 grand

01:51

today. it bought this and this and yes this so how is the average Josephina

01:56

able to plunk down 40 grand just on one stock?

02:00

well she's not. you know your grandma gooses catchphrase right? well the same

02:04

applies to investing four grand could be a life savings back then, and of a simple

02:09

retail investor put all her money in one stock and that stock tanked, then she was

02:15

Sol or sweetly out of luck. so mutual funds allowed that little guy investor

02:20

with very small amounts of money and for most it was a minimum of about two

02:25

hundred and fifty bucks, and it still applies today to pool his money with

02:28

thousands of other investors and get exposure to a basket of stocks. the fancy

02:34

$5 word here is diversification, and when assets are pooled that four grand of

02:39

mutual fund ownership might look something like this. well if a thousand

02:44

investors each put four grand on average into an investment pot well that would

02:48

give the pot four million dollars of buying power and it allow them easy

02:52

access or liquidity to have their four grand invested in a wide range of stocks

02:57

and bonds in whatever form they want it. and with a large pot of money to put to

03:01

work might they also get the ear of the company's CEO for 15 minutes a quarter?

03:06

would that ear make them invest the dough a bit more readily smartly better?

03:11

well maybe and at the end of the year let's say that four million was invested [chart picturing increase]

03:14

well and it has a value of 4.4 million bucks, that is it went up 10 percent in

03:19

a year. well when the thousand partners formed

03:22

the fund they agreed that they would divide the fund into slices of pie in

03:26

the same way that ownership of a company is divided into shares. well remember

03:31

Apple has over five billion shares outstanding. they trade it in 150 bucks

03:36

or so a share and multiplying the two together gives them a total market value

03:40

today of over 800 billion dollars. well the mutual fund might have two hundred

03:45

thousand shares outstanding so that at four million dollars of value

03:49

you to get the net asset value per share, or nav. you divide that total pi value by

03:56

the number of slices in it to get 4 million over 200,000 or 20 bucks a share.

04:01

now if the fund goes up 10% the number of shares outstanding in this scenario [equation]

04:05

hasn't changed, so the net asset value per share would be 22 bucks a share a

04:10

gain of 10%. in real life however investors buy additional shares in a

04:14

mutual fund and redeem them every day. why well they buy because rich uncle

04:20

Larry died and left him a million bucks and they already had that cool caveman

04:23

stereo. and they might sell because while the fund had a lousy performance and

04:27

their P.O.ed. or they might sell because the fund had great performance

04:31

and since they know that most investments regress to the mean ie

04:35

come average over time, they want to sell their mutual fund shares take their

04:38

chips off the table today and put the dough elsewhere. so let's say a new

04:41

investor comes in and wants to invest 6 grand in the fund, which closed at the

04:46

end of today at exactly 20 dollars a share. well let's also say that on this

04:50

given day everybody was happy with their investment. nobody wanted to sell and

04:55

nobody wanted to buy other than this one guy. well unlike bond shares an Apple

05:00

Walter doesn't need another already existing investor to sell him the shares.

05:04

he can buy six grand divided by $20 or 300 shares of the fund. those shares

05:09

didn't come from a disgruntled or even a gruntled other investor. they were sold

05:14

directly by the fund itself. well the analogous situation would be if

05:17

Apple sold shares directly to the public. those things do happen they're called

05:21

IPOs and they're also called secondary offerings, but they're not a daily event.

05:25

so a mutual fund shares sell to the public every day like we noted, and after

05:29

this transaction the investor now has 300 shares of this fund, a fund which now

05:34

has two hundred thousand three hundred shares outstanding. the value of the fund

05:39

went up the six thousand dollars that was put in so the funds value is now two

05:44

hundred thousand three hundred times twenty bucks or four million six [equation]

05:48

thousand dollars. and Walter now owns three hundred divided by two hundred

05:51

thousand or 0.15 percent of the which is money we're sure he'll

05:55

eventually spend wisely when he cashes out. he's having fun. you'll just have to [man drives red sports car]

06:00

trust us on this one.