Episode #8 - A warning and Mutual Funds
TW for death by suicide in the intro. Skip intro if you'd prefer not to read about it.
Intro:
Folks, a few times in this letter I’ve shared the “free” stock trading app Robinhood. Over this past week a horrifying story emerged of a young man named Alex Kearns (20 years old from Plainfield, IL) who died by suicide because he thought he was $730,000 in debt due to complex trades on Robinhood. The folks at Robinhood responded with this note addressing some issues with user interface that led to Alex’s confusion with how the app worked when it came to options trading.
With the closure of casinos across the country, many young people have taken to gambling with their savings in the volatile stock market. While many other addictions have more tell-tale signs (such as alcohol and drug abuse), spiraling into debt (or even worse, THINKING that you’ve spiraled into debt because of a user interface issue) can happen in the confines of a sleek application and no-one else would know about it. While we continue to wade into the world of investing for your future and related topics, I urge you to make sure you’re not feeding any dangerous habits with the market. It’s a real place, where you can lose real money and understanding what you’re doing will protect you.
For the purpose of this letter, I’ll move to the expected feature on mutual funds as an add-on to the last issue about ETFs, but in the future I will spend some time elucidating how these “free” trading apps work and why the risk is so great.
Background:
Conveniently, the FIRST known mutual fund was also an outgrowth of everyone’s favorite British East India Co. that I’ve referenced in previous episodes. In the words of our friends at the Investment Funds Institute of Canada, it was the first “to big to fail” corporation and was bailed out by a failing British treasury. It was with this historical reality that a man named Adrian van Ketwich did the clever act of gathering money from a few different investors and used that money to make a diverse set of investments across European countries and the “New World” (i.e. old world that was being colonized aka America).
Fast forward to 1924 and you meet the first modern-day mutual fund:
The first modern-day mutual fund, Massachusetts Investors Trust, was created on March 21, 1924. It was the first mutual fund with an open-end capitalization, allowing for the continuous issue and redemption of shares by the investment company. After just one year, the fund grew to $392,000 in assets from $50,000. The fund went public in 1928 and eventually became known as MFS Investment Management. (h/t Investment Funds Institute of Canada - never thought I’d quote a Canadian article twice in one note.)
These funds can be bought and sold one time per day and provide more active management than what you might receive with an exchange traded fund. Remember, having a diverse portfolio made with your own purchasing gets super expensive and complicated to manage SUPER quickly (if you tried to mimic the S&P 500 and started by buying one share of Amazon you would already be down $2,675, while you could invest in the full S&P 500 with a mutual fund at about $2,500).
Ok, you’ve got my attention, tell me more:
Well, thanks for asking. Another advantage of the mutual fund comes in the form of a fancy financial manager who buys/sells new stocks in the suite of items in your fund. This active management does lead to higher fees than what you’d see for an ETF, but you hope to pay for the wisdom of a money manager who knows that they are doing.
The mutual fund doesn’t always only contain stocks, it will often contain bonds or other securities that make it more diverse. It removes the pressure from the average investor to ensure that they have a wide range of investment options in their arsenal. For some mutual fund lingo: “expense ratio” is the code word for the fee you pay to the company that manages the mutual fund. Again, if you like the work that they do, then it’s certainly money well spent. A useful distinction to remember is that when you buy into a mutual fund you don’t get a “vote” as to what the companies that are in the mutual fund should do. When you buy a stock outright, you do get that input.
How do you make money from a mutual fund? Our friends at Investopedia show three ways:
Income is earned from dividends on stocks and interest on bonds held in the fund's portfolio. A fund pays out nearly all of the income it receives over the year to fund owners in the form of a distribution. Funds often give investors a choice either to receive a check for distributions or to reinvest the earnings and get more shares.
If the fund sells securities that have increased in price, the fund has a capital gain. Most funds also pass on these gains to investors in a distribution.
If fund holdings increase in price but are not sold by the fund manager, the fund's shares increase in price. You can then sell your mutual fund shares for a profit in the market.
There are more advantages to the mutual fund model, but at this stage I will leave the further study to you. If you want to talk about them, respond to this note!
Takeaway:
Mutual funds get you the economies of scale usually experienced by large institutional investors. You can’t get into the total market with $200 on a regular day, but if you join a mutual fund you pay a 1-3% fee and you get access to the whole market (or some specific subset). These funds are highly regulated and you do get access to see what they are trading. You get access to a variety of investments that you may not even know exist! As we covered ETFs last week, you now see that there is another side to the story and mutual funds might be a better way for you to care for your money.
In case you’re too scared to jump into either, stay tuned for next episode where we’ll get into the blow by blow comparison.
Interact:
Take a look at some of the biggest mutual funds in the industry. Then take a look at some of the more “niche” markets. Tell me, what is the most niche market you found that you’d want a piece of. Then buy it! Or at least screenshot it and send it my way!
One thing to note, I recently heard Suze Orman (on the Pivot podcast) say that the key at this volatile time is to invest in the TOTAL MARKET not just the S&P 500 because then you get the most diverse exposure and eliminate some of the risk of following the S&P.
Gratitude:
Thank you to our 100th and 101st member of Winnings. It took a little longer to get here than I thought it would, but we’ve made it over the hump. Now please share it with your friends/family!