I was a new graduate from Pharmacy school when I was first tasked with picking investments for my 401k. I glanced through the long list of funds from Fidelity and attempted to make the “best” selections. My parents didn’t have a 401k (or IRA) so I couldn’t ask them for help. Most of my friends were in the same boat as me so they weren’t very insightful. YouTube wasn’t created until five years after this decision so I couldn’t watch a video of some expert. The list provided to me from HR had 30+ different names of “funds” that I had to pick for my very first retirement account.
I thought to myself, “Do I pick one? Do I pick two? How do I know what to pick?”. As with most decisions in my early 20’s, I jumped right in and made important decisions without much thought .
–Fidelity Contrafund – Cool! I was a huge fan of video games and clearly remembered playing Contra on my Nintendo so I had to add this one to my list.
–Fidelity OTC Portfolio – OTC portfolio? Kinda sounds like “over the counter” medications. Being a Pharmacist I had to pick this one! Weird that I couldn’t find the Fidelity Prescription Portfolio.
–Fidelity Magellan – I was a big fan of traveling and exploration (i.e., Ferdinand Magellan) so this one was added to my list.
I literally picked funds for my 401k based on the coolness of the name. I absolutely had no idea what I was doing (clearly). Luckily, I made some good selections at random but an understanding of investment funds would be needed if I were to change jobs.
That job change happened three years later.
Brief History Lesson
“Pooled Funds” (aka Mutual Fund) have been around for centuries in the UK, Netherlands, and France. In the United States, the first mutual fund was the MFS Massachusetts Investors Trust in 1924 with $50,000 in assets that quickly grew to over $14 million by 1929. The fund pooled together money from multiple individuals for a fund manager to invest in the stock market. Thus, the individual investor gave the fund manager the right to invest their money along with with other investors. Competitors quickly saw this concept of “pooling funds” from investors as profitable so mutual funds popped up across major investment banks. As of 2021, there are nearly 8,000 mutual funds available.
A different kind of mutual fund was created in 1976 by Jack Bogle. Jack Bogle was the founder of the Vanguard Group and is credited for creating the first index fund in 1976. The “Vanguard Index Fund” was a low cost mutual fund that didn’t rely on a fund manager to actively manage the fund and instead tracked a broad index (i.e., Dow Jones, S&P 500, etc). Jack is sort of a legend in the investing world and is recognized as being one of the most influential investors in the past 50 years. His philosophy has been followed by many.
Jack Bogle Investment Philosophy
- Select low-cost funds
- Consider carefully the added costs of advice
- Do not overrate past fund performance
- Use past performance to determine consistency and risk
- Beware of stars (as in, star mutual fund managers)
- Beware of asset size
- Don’t own too many funds
- Buy your fund portfolio – and hold it
“Don’t look for the needle in the haystack. Just buy the haystack.” – Jack Bogle
Mutual Funds vs ETFs vs Index Funds
Picking a single stock may seem easy because it is clear what you are buying. However, individual stock picking can be very risky to an untrained eye and to individuals that don’t research a company. Moreover, if you are risk adverse and can’t stomach the thought of wild swings in a stock’s price then picking an individual stock may influence some financially devastating decisions (i.e., selling at a loss). The alternative is buying a fund that is composed of several (in some cases thousands) of companies all within a single fund. Luckily, we have three major options.
Type of Funds:
- Mutual Fund – A diversified investment fund that is made up of multiple investments (i.e., stocks) with a goal to BEAT the market. Mutual funds are typically actively managed by a professional fund manager whose job is to buy and sell stocks within the fund according to the fund’s goals. Mutual funds are bought and sold at the end of the trading day.
- Exchange Traded Fund (ETF) – A diversified investment that is made up of smaller investments but may be bought and sold throughout the trading day. ETFs may be actively or passively managed funds depending on the fund’s goal.
- Index Fund – A type of mutual fund or exchange traded fund made up of multiple investments (i.e., stocks) with a goal to MATCH a broad index (i.e., Dow Jones, S&P 500). Index funds are passively managed so fees are much lower than actively managed mutual funds or actively managed ETFs.
The big difference between ETFs and mutual funds is that it can be bought and sold throughout the day much like a stock. Mutual funds and index funds can only be purchased at the close of the trading day. There are also some big differences with the fees associated since mutual funds are actively traded by a professional fund manager, and index funds and most ETFs are passively managed. Mutual funds typically have higher fees as such.
Benefits of Fund Investing
Easy – Most investors and everyday individuals that are saving money for retirement are not financial analysts. We don’t have time to properly pick an individual stock let alone read a financial statement.
Minimize Risk – Pooled funds minimize the risks associated with single stock picking. When buying a pooled fund you are betting that an individual fund manager can do better than you or you are betting that the market or specific sector will grow.
Fees – Index funds and most ETFs have very low fees because they are passively managed. It is usually cheaper to simply purchase a few index funds vs. paying a financial advisor to manage your assets.
Beware! Many Mutual Funds can very high fees so check the expense ratio before purchasing a Mutual Fund. I consider anything above 0.5% expense ratio to be high.
Saves Time – There literally is a fund for every kind of investing strategy. There are funds for different sectors of the market (healthcare, energy, technology, etc), funds that track the entire market or specific indexes, and international funds. There is no need for intense research into the companies you wish to invest in. Let’s say you really care about the environment. There dozens of funds that are composed of companies involved with solar energy, wind energy, and other environmentally conscious products and services. For those that don’t have a soft spot for the environment, there are hundreds of funds that only invest in coal, oil, mining, and other fossil fuel exploration and production.
Proven Track Record – Actively managed mutual funds typically perform well in the short-term but underperform after one year due to fund manager risk and management fees. Index funds and ETFs, however, have proven to beat actively managed mutual funds over time.
Mutual funds and ETFs are like a bowl of fruit. You buy the bowl (i.e. fund) and within the bowl are various pieces of fruit (i.e. individual stocks). If any of the individual fruit goes bad then it may be discarded and replaced with new, fresh fruit. Mutual funds and ETFs do the same thing. Companies that are failing and not producing returns will be removed from the fund and replaced with new, fresh companies with better potential.
No. This is not a subliminal message to buy Apple stock. Just buy a fund that has Apple stock!
Helpful Resources
What is my approach to Fund Investing?
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I don’t have time to properly research a company’s balance sheet, quarterly investor call, etc so individual stock picking is too risky for me.
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I invest a majority of my retirement and brokerage accounts in Index Funds and some low cost mutual funds and ETFs.
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I do not invest in any bonds or target date funds. Target date funds usually have very high fees and bonds are not needed at my age since I am building wealth and not protecting it. (I am in my 40’s.)
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I use a three fund strategy (S&P 500 fund, small/mid-cap fund, and international fund) for the bulk of my portfolio.
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I maximize all retirement investment vehicles annually. This includes my 401k, HSA, Roth IRA, and SEP IRA.