In memory of the great Jack Bogle, this seemed like as good of time as any to start talking about mutual funds. As the founder of Vanguard, Jack Bogle, is often credited with being the father of low cost-index funds which is a type of mutual fund. Mr. Bogle passed away this year on January 16th , 2019.
So, what is a mutual fund?
The best way I view a mutual fund is as a pool of money that is created from contributions from individual investors like you or me. This pool of money is then used to create a portfolio of different stocks and/or bonds managed by the mutual fund company. Your individual portfolio growth is then determined by how well the mutual fund company’s portfolio grows.
So instead of buying and owning a share of Apple, Google, Disney, or Amazon, you may own a small fraction of these companies in your share of the mutual fund you own.
Why does this matter?
Because only owning a small portion of many different companies limits the risk of owning individual stocks.
“But I would be rich had I bought individual stocks of Amazon”
Which is true, at least currently, but what if you had been investing in stocks such as Blockbuster, K-mart, Kodak etc. How rich would you be now?
The list of “dead” stocks/companies is long, but I tried to list a few people may remember. And if you don’t remember these? Then, damn I’m getting old! What about Vine, remember Vine?? How big did Vine used to be? Although bought by twitter, how great is Vine doing right now??
The point is, companies come and go, and if you think you can predict the future of these companies, you are lying to yourself.
“But _______ (*insert any public investment figure), told me to buy this stock and now I have made 25% on my money”
Again, this happens, but show me the articles or the people who get these guesses wrong?
You can’t?
Exactly, these articles are buried, and these investment advisers don’t become public figures or aren’t employed anymore. We don’t publicize the thousands of people who make incorrect guesses every week about the market, just those that “hit”.
If you make enough guesses about the stock market, eventually, someone will get one right. These people who “hit”, are hopefully smart enough to realize their luck. However, few do, and then try to replicate their success, only to fail.
Experiment: Ask a coworker, friend, family member about how their investing has been going? If they invest in individual stocks, I personally guarantee they will tell you about the “winner” they invested in.
How they just “knew” that ______ market was going to blow up this year or how ______political change would cause ______stock to boom. I know this because this used to be me. No one talks about all the “losers” they picked and if they do it’s followed with an excuse.
People want to look smart and rich, and even more so if they are in the public eye.
Not to mention, these people picking the “winners” spend most of their day researching these stocks, meeting with these companies, and doing market analysis. They still can’t beat the market all that often.
How do you expect to beat the market when you work a full-time job, have a family or other responsibilities???
The Problem with Mutual Funds
As with all good things, there are things we need to be aware of. In life not all things are created equal and the same can be said of mutual funds. As I mentioned, mutual funds are larger scale portfolios being actively managed, so they charge a fee.
This is the expense ratio or ER. This can be viewed as the mutual funds operating costs which is usually given as a %. The more actively managed the account is, the higher the expense ratio becomes. These expenses can get as high as 2-3% and in rare cases can go even higher.
But what does this mean?
Don’t worry baby bird, I’ll feed ya. All this means is that at an expense ratio of 3%, you are charged $3 for every year that you have $100 dollars invested.
You: “Well, $3 isn’t much money”
Again, true. For early investors like myself, this doesn’t seem like much money for the year. But, when we scale out to the big picture, we realize that most people require millions of dollars to safely retire. (Likely due to our horrible spending habits but this is not the point of this post).
For simplicity sake, let’s say we can retire on 1 million dollars. At a 3% expense ratio, it now means we are PAYING $30,000 dollars PER YEAR in operating costs!
That’s nearly a starting teacher’s salary in fees!! I can make these jokes as I come from a family full of teachers.
The worst part is that this is $30,000 is not working for us anymore. I love compound interest but not in this situation. $30,000 with a conservative 7% growth rate over 10 years turns into over $60,000. We have now doubled our losses…Ouch. Let’s pretend we won’t have to pay even more in fees next year…
Enter Jack Bogle and Vanguard
When Mr. Boggle created Vanguard in 1975, he started popularizing low-cost index funds along with it. As this post is getting long, I plan to create a separate post to describe the magic of index funds, but lets briefly touch on just how low-cost Mr. Bogle’s mutual funds were.
He looked at all these high cost actively managed mutual funds out there and created index funds with expense ratios as low as .04%. Our savior!
So now our hypothetical 1 million dollars now loses just $400 per year in operating costs. Do you see the difference yet? I for one, like keeping my money.
Let me know what you like to invest in below
Feel free to comment below with any questions or if you have specific or personal questions feel free to contact me here!
