Money Monday: What Is a Mutual Fund?August 6th, 2012 by Aaron Koo
As an outsider observer looking into a mutual fund, though, I think it would be fair to say that we can intellectually reason out more or less the purpose of using one. Even so, let’s satisfy our inner curiosity and have a more in-depth look at the inner workings of a mutual fund.
Why Create a Mutual Fund?
The fund manager selects the stocks to go into his funds, and then he offers a selection of different funds to meet the needs of his investors. They have conservative funds that are low yielding and very secured investments, made up of bonds, T-bills, and GICs (guaranteed investment certificates), all the way to equity funds made up of stocks for the people looking for greater return over the long run.
For simplicity’s sake, let’s focus on a typical equity fund. Our fund manager has a look at the stock market and decides he likes AAPL (Apple), GOOG (Google), and PCLN (Priceline.com). A typical fund would have way more than three stocks, but let’s keep it simple. All the stocks I chose are more then $500 a share (AAPl=$615, GOOG=$641, PCLN=$663). In order to buy one of each, I’d have to pay $1919. Not exactly on everyone’s radar, especially when most people don’t save to begin with.
How Do You Get Involved?
The fund manager will then shrink the price by selling units of their fund. A unit is a stock that’s been broken down so the average consumer can afford it. The fund manager would sell a unit for $10, for example. Let’s say he sold 10,000 units giving him a pool of money worth $100,000.
Assuming the fund was made up of equal amounts of each of the stocks he would take that money and buy 52 shares of each of the stocks. Let’s say you purchased 20 units (total book value of $200). Let’s also say that the overall value of the stocks went up 10%. This would mean that the fund units would have grown to $11 per unit, and thus your units would’ve grown to $220 since you bought the original 20 units.
A Simpler Way to Invest?
There’s a lot more on this topic than can fit into this post, but for the layman who’s curious about how the fund itself works, this will hopefully shed some light and create more confidence in your investment decision.
Filed under Money.