If you pay any attention at all to the workings of Wall Street, then you have heard of the term diversification. This is a term that means spreading one’s money around the market. Many investors do this as a way of spreading their risk around. Over time, this has been shown as one of the best ways to make the most money in the stock market.
What Is A Mutual Fund?
A mutual fund is the primary way that investors can use this diversification strategy. It is a vehicle that allows investors to have their money spread around the market for them. Basically, the investor puts their money into the fund, and the fund manager takes that money at places it into a number of different investments for them. This is done so that the collapse of any one particular investment does not cause the downfall of any investor’s entire portfolio.
Why Not Individual Stocks?
Some people still think of the stock market as a place of individual stocks. In a way that is still how it works. You are able to invest in individual companies if you so choose. The only problem with this individual stock picking game is that you stand the risk of putting all of your money into a sinking ship. Take the example of investors who put their money into Enron stock. If they had put most or all of their money into this one stock, then they likely lost most of their money. However, if they had decided to instead put some of that money into a mutual fund, they would likely not have been hurt by the downfall of Enron.
Another benefit that many mutual funds offer is something known as dividends. These are payments that are made out to investors every quarter. These dividends come from the extra money that companies have left over after they have paid their expenses. They give much of that money back to investors as a way of rewarding them for owning part of the company. With a mutual fund, the investor owns several small pieces of many companies. This means that they may be collecting small dividends from many companies. It is just an added bonus for leaving your money were it is. You are getting paid for doing nothing! Many of the funds also allow you to automatically reinvest the dividends that you receive. In this way, you end up owning even more of the mutual fund, and your dividend money starts to grow dividend money. This cycle is repeated over and over, and it has made some people very wealthy indeed.
Mutual funds are something that all people should consider over their individual stock picking. You never know when you might end up with the next Enron on your hands.