Despite a recent softening in the market, the mutual fund industry continues to reach record highs.
In December 1999, the assets of the nation’s mutual funds were nearly $7 trillion, an increase of more than $1.5 trillion from 1998. Just 10 years ago, total mutual fund assets were $1 trillion, and since 1990, growth in the industry has been explosive.
Mutual fund ownership grew faster than any other financial instrument over the 1990s, and the popularity of mutual funds makes them the core vehicle for many people’s savings and retirement needs. The percentage of U.S. households owning funds rose from 25 percent in 1990 to nearly 50 percent in recent years. Among households with annual incomes of at least $50,000, 70 percent own funds.
There are approximately 12,000 mutual funds available, more than the number of individual securities listed on the New York Stock Exchange. With so many, sorting through them can be overwhelming.
Mutual funds offer many benefits. They provide diversification by pooling the money of many investors and investing it in a variety of securities to achieve a specified investment objective.
Diversification is one of the best ways to achieve investment success. It spreads your risk and earnings potential over a portfolio of various securities that provide increased potential for higher return and reduced severity of market volatility.
However, some people carry diversification to the extreme — they invest in multiple funds with the same or similar styles, believing they are getting greater diversification. In reality, there is portfolio overlap, with many funds carrying many of the same stocks.
The success of mutual funds is, in large part, based on the fund manager’s investment skills. The manager decides when to buy, when to sell and when to hold stocks in the mutual fund’s portfolio. That person’s decisions are based on extensive research and other information, such as the health of the individual companies and general market and economic trends.
Mutual funds offer investors the ability to purchase or liquidate shares at the current market value, which may be worth more or less than their original cost. Current per-share net asset values are calculated daily based on the market value of the underlying securities in the portfolio.
Investors in mutual funds, outside of retirement plans accounts, should consider the impact of income taxes on their returns. This is because each year, mutual funds must distribute substantially all of their dividend and interest income and realized capital gains to their shareholders.
Some mutual funds have portfolio turnover of 100 percent or more, which results in large capital gains distributions. Investors are taxed on these distributions, even if they reinvest the money in new shares. Since investors want to maximize after-tax returns, tax-managed mutual funds were developed to meet the needs of those holding mutual funds outside of retirement plan accounts.
Mutual funds are a good way to build a professionally managed and diversified portfolio. However, selecting the right funds can be time consuming and overwhelming. That’s why it’s a good idea to consult a financial adviser for assistance.
The bottom line: Don’t put your money at unnecessary risk. Arthur Weisman is a financial adviser for First Union Securities. He can be reached at (216) 574-7317.
