Investing in Mutual Funds

Hacks #59-72

The first U.S. mutual fund, a common stock fund, was founded in 1924. 1940 saw mutual fund assets reach $500 million and the enactment of the Investment Company Act, which defined the framework for the regulation of the mutual fund industry. It took another 45 years for mutual fund assets to reach $500 billion. However, both the proliferation of 401(k) retirement programs and the increasingly diverse selection of financial assets available through mutual funds helped the mutual fund industry come of age in the 1990s. By mid-2003, after almost four years of poor market performance, mutual fund assets stood at almost $7 trillion.

Some investors put their investment dollars in mutual funds because that's what their 401(k) retirement plans offer. But many more investors have invested willingly in mutual funds to obtain diversification and professional management—more easily and at lower cost than investing in individual stocks and bonds. In addition, as the pace of life has increased, plenty of people have grown fond of mutual funds as the no-muss, no-fuss investment. With professional management, many investors think that mutual funds provide good investment returns without any effort on the part of the mutual fund shareholders.

Perhaps things got a bit out of hand in the 1990s. A long bull market and steadily decreasing interest rates made just about every investment—stocks, bonds, mutual funds, real estate—look good. Potential investors looked no further than recent sky-high returns and rushed to buy shares, fund prospectus unread, salivating at the prospect of more market-beating returns. In fact, many gladly paid several percentage points worth of expenses and fees, thinking that years of extraordinary investment returns were worth the cost. Of course, the inevitable and long-overdue bear market hit, and the highest flyers (mutual funds and stocks alike) hit the ground the hardest. Mutual fund shareholders started to question the sanity of paying two percent or more in expenses to mutual funds that lost more money every year.

A few years later, just as the market was dragging itself out of its bear cave, the mutual fund scandal broke. As it turns out, some of those professional managers weren't acting so professionally. Mutual funds have a fiduciary responsibility to protect the financial interests of their shareholders. However, some mutual fund managers and executives were allowing and even participating in activities that made them money at the expense of their shareholders.

All this excitement has some investors questioning whether they should trust mutual funds with their money. With other scandals, including Enron and WorldCom, you might wonder if there's any investment you can trust. In the end, all this excitement could be the kick everyone needed to get their mutual fund and overall investment act in gear. Maybe now, investors will diligently research mutual funds (not to mention individual stocks and bonds) to make the best investment with their money. Perhaps the mutual fund scandal has made the SEC see that additional regulations are needed, and has also helped fund shareholders appreciate tried and true mutual funds that understand the meaning of fiduciary responsibility.

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