Our focus this week has been on learning about different types of securities. Here's a piece Nancy wrote in 2000 explaining some of the basics of mutual funds. Enjoy the throwback!
I drove down Clinton Boulevard past a dilapidated building. Twenty years ago, this was the Old Ladies Home. The name was inscribed across the front of the building. As I passed, I remembered a time when places were named by their function. The Old Ladies Home was really the old ladies home. And the insane asylum was called the insane asylum. No pretense. No politically correct euphemisms. The name said it all.
Now, both may be referred to as manors, inns, centers, or systems. And many have flowery names that belie their interiors.
Thank goodness such is not the case with mutual funds.
For many of us, the bulk of our investing is done within a retirement plan. We have a plan available through our employer that allows us to put aside money for our golden years. These are sometimes called 401(k)s, Profit Sharing Plans, etc. We choose to contribute (or not). We decide how much to contribute with each paycheck. And we select the mutual funds in which this money will be invested. It's that last part that gets most people tripped up. And that's where a mutual fund's name comes in handy.
Much can be understood about a fund by simply looking at the name. Funds that invest in short-term commercial and act like savings accounts will, usually, have "money market" or "cash" in the name. Many bond funds actually have the word "bond" as part of the name, like Vanguard Municipal Bond Fund. This tells me this fund invests in, not just any bond, but in tax-exempt municipal bonds. Some bond funds use the term "fixed income," such as Warburg Pincus Fixed Income Fund. This is just another phrase used for bonds. With bond funds, the name will usually indicate the term of the underlying bonds, such as short-term, intermediate, or long-term.
If you see the word "equity" in a mutual fund's name, you know you're getting a fund that invests in stocks. When the word "income" appears alongside the word "equity," you are probably getting a fund that invests in stocks that pay dividend income. The same can be said of growth and income funds.
Many stock funds are defined by the size of the companies in which they invest. Large-cap funds invest in big companies like IBM, Intel, or Ford. Mid-cap funds invest in medium-sized companies, and small-cap funds invest in small companies. Remember, though, small-cap companies may grow into large-cap companies and still be held by that small fund.
Other stock funds are defined by their investment style. A growth fund invests in companies that promise high growth without regard to the market price. A value fund looks for a good value (a bargain). This funds wants to find a stock that is underpriced. And an aggressive growth fund is the high-octane variety of the growth fund. These tend to be more volatile than their tamer siblings.
Some stock funds are specialty funds, investing in only one sector of the market. Vanguard Healthcare invests in pharmaceuticals, HMOs, nursing homes, medical supply companies, etc. T. Rowe Price Science and Technology Fund invests in the high-tech area. Gabelli Gold Fund invests in gold mining and, possibly, actual gold. And Fidelity Select Resource Fund invests in timber, oil, and other natural resources, while Scudder Real Estate Investment Fund invests in real property in one way or another.
One type of specialty fund that has become popular is the index fund. Most will have the word "index" in the name. These are imitator funds. They buy the same stocks in the same proportions as the index they are imitating. The trick is to know which index. Many will have the index name in it like WEBS Index Italy. This fund follows the stock index of the Italian exchange. Some will have a number that offers a clue such as Vanguard 500 Index. This fund invests in the stocks of the S&P 500 Index.
Some funds invest in stocks of companies that are headquartered outside of the United States. You may note the word "international" in the name. These funds will invest everywhere except the U.S. Other funds will have global or worldwide in the name indicating the hold companies that are within the U.S., as well as those outside of the U.S. And still other funds invest in companies of only one country or one region. Usually, the country name is part of the fund name. Balanced funds invest in cash, bonds, and stocks. These are all-purpose funds, designed particularly for new investors or those who are quite conservative. They may also use words in the name such as "total return," or "asset allocation."
A mutual fund's name can also give you clues about the commission that you are paying. If there is an "A" in the name, this is a front-end load or commission. That means that your purchase is reduced up front by the amount of commission due the broker. If there is a "B" in the name, this is a back-end or deferred load. That means your account will be reduced by a certain percentage each year to pay the broker. If you try to cash out of these funds before the broker has received his full compensation, you will be assessed additional charges. Some funds have other cryptic symbols, such as C, T, or I. When you see one of these, it's time to read the fine print in the prospectus.
A mutual fund with no letter in the name may mean a no-load (no commission) fund, but be careful. Again, read the fine print. Whether investing in your company retirement plan or investing on your own, a mutual fund's name is the first place to start. Study the name for clues as to how your money will be invested and what it will cost you. But always remember to peek inside the prospectus. The name may not match the interior.
After all, you don't want to drop Grandma off at the insane asylum!
--Nancy Lottridge Anderson, H&H, June 2000