You might know a mutual fund under many names, including a superannuation fund, but they are a collection of some amount of stocks, bonds, cash, or other securities. When you join a mutual fund your money is put together with all the other mutual fund investors. This allows the fund manager a much larger bank roll that allows them to purchase specific securities. Buying securities in large packages also helps to reduce the transaction costs.
These securities might be focused on one class, say government bonds or blue chip stocks, or a diversified mix including corporate bonds from manufacturing companies, local or international stocks, or anything that the fund manager thinks is a good bet.
The main benefit of these mutual funds is that you can have your money included with the big players and their associated buying power. For example for many years bonds were only purchasable in $500,000 bundles. This puts access to most bonds out of the reach of the regular investor. Even now you’re required to be a sophisticated investor with over 2.5 Million in assets to get access to the large collection of wholesale bonds.
It also helps remove from you the time and experience requirement to investigate, plan, and implement a good investment. Instead of spending hours each day watching the market, reading the latest company news, checking the government plans, you leave it to someone else to do that job for you. The main idea being that a professional will more often than not do a lot better than the amateur. But just like any professional you hire, they’ll be charging you for the privilege of working with them. This might be as a flat fee, a percentage of your investment or both.
The fund also allows you to spread the investment across different security classes. Usually to spread risk. So a loss in one particular class or stock doesn’t impact your gain as much as having all your investments in that one class. At the same time, it can catch situations where one class grows more than others.
Being part of a mutual fund also helps you stay liquid and have an easier time to get all your money back from when needed compared to other direct investment securities. Although retrieving your funds early usually incurs heavy penalties and extra fees.
One major disadvantage of mutual funds is there’s no real way of evaluation their future performance. There’s no earnings report, sales data, or industry metrics like there is with a listed company. All advertising and documentation of their performance is based on their past performance. Usually documented as the last 6 months, last year and last 5 years. And somewhere on that documentation will be something like the statement: “Past performance are not indicative of future performance”.
The worst thing that these funds won’t tell you about inter fund performance when you look at these funds over time. A super provider often has 5 or 10 different funds to choose from. But you’ll see them shift and change names and results as the fund owners stop the failing ones and continue the winning ones. You can see evidence of this as there are not many funds with a 10 year or more history. This leaves a very heavy survivor bias.
Survivor bias is best described as excluding failed or closed funds from the overall performance studies. This often causes the results to be skewed higher as only the successful funds are included.
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