Investment Training Wheels
In a previous article I made a comparison between mutual funds and investment clubs. I wanted to give a few more details on why I think the analogy works. Not because I think mutual funds are the greatest investments in the world, but because they have a lot to offer beginning investors.
Mutual funds are like training wheels. They help you keep your balance when you’re learning to ride the investment cycle. As with any new endeavor, to be proficient, you need to jump in or jump on. Learning theoretical information without putting it into practice is impractical.
Show me a cook that hasn’t experimented with recipes and I show you a mediocre or bad cook. Find a person that took a dancing class and just read the book and they’ll dance like their looking at foot silhouettes. A person that reads everything on art theory but never picks up a brush can’t be called an artist.
The same is true with investing. However, a cook that makes a bad souffl√© can throw it out and start over; a dancer can replay music and retrace steps; an artist can start a new drawing. With new investors it’s not that easy to recoup loses. So how do you get the experience without exposing yourself to undue risk?
Earlier, I used the metaphor of training wheels with mutual funds. Now let me tell you why in the context of investing. For one thing, when you invest in a mutual fund you’re trusting the investing expertise of someone else. The fund manger’s sole purpose is to select a portfolio with high performing securities.
For fund mangers, investment clubs and individual investors, exposure to risk should be the biggest concern. Creating a balanced diversified portfolio is one solution. The more stocks you have in a portfolio reduces risk. Then you’re not relying on one stock’s performance. That’s the advantage a mutual fund offers. This kind of investment is considered to be common yet effective. To some degree an investment club can do the same thing depending on the amount of financial resources its members have. Next, the investment objectives should be the key principles governing how any portfolio is managed.
Reading a fund’s prospectus is a good way a beginning investor can get a feel for a fund manager’s investing strategy. I’m not advocating reading the whole thing, but just the areas that deal with the fund’s philosophy. One great advantage today is that most prospectuses are on line. Sometimes the prospectus will even give a listing of the portfolio’s holdings.
If major holdings from the fund are listed this can be an extremely beneficial tool new investors can use. Sometimes there’s an explanation for the choices. This can give valuable insights into a professional manager’s mind. Don’t worry if you don’t grasp everything at first that will come with time. You might even surprise yourself with the things you do know. In time you’ll be looking at investments from a keener perspective. That feels good and then it starts to get fun.