Shotguns and Money

WALL STREET SMARTS, THE BLOG, IS NOW WALL STREET SMARTS, THE BOOK.  FULLY EDITED AND REVISED WITH NEW MATERIAL ON AMAZON

Hunters have the option to use either a rifle or a shotgun, depending on what is being hunted.  Similarly, investors have the option to purchase either a specific investment or a mutual fund.  In order to diversify a portfolio, the individual stock purchaser must spread his or her money over a number of companies in different industries.  You may recall that the collective advice of the value investors we have studied in earlier posts is to purchase between ten and thirty different companies, each in a different industry.  For an investor just starting out, the successful assembly of such a portfolio will take both time and effort.  Not everyone has the time or the inclination to do this.  Once a person starts a career and has the funds to invest, there never seems to be enough time for much more than work, family and friends.  Most retirement plans offered by employers offer only mutual funds as investment options.  Many individual investors take the shotgun approach and put their money into mutual funds.  It would seem that a majority of people in the market do so via pooled investments.

Pooled investing has been around for centuries.  Many financial historians point to a Dutch investment trust (called a negotiatie) as the first such investment established in 1774.  Its stated purpose was to provide diversification to individual investors at a small cost.  Numerous negotiaties were organized in the latter part of the 18th century to invest in the credit of a new country, the United States of America.  The organizer of the original trust, Adriaan van Ketwich, organized a second one in 1779 which remained in existence for 114 years.  It was dissolved in 1893, the same year that The Boston Personal Property Trust, one of the first American investment trusts, was formed.

The fore bearer of the modern American mutual fund, the Massachusetts Investors' Trust, was established as an open-end fund in Boston in 1924.    The Wellington Fund, launched in 1928, was the first mutual fund to specifically invest in both stocks and bonds, a balanced fund.  The value investor, Phillip Carret, was one of the organizers of the Pioneer Fund in 1928.  Pioneer is still in business today.  The number of funds increased over time, but many were wiped out during the 1929 Wall Street Crash.  Investigations into these failures revealed a fair amount of chicanery and self dealing on the part of the operators of the  failed mutual funds.  This led to the passage of The Investment Company Act of 1940 which placed numerous restrictions on the operations of US mutual funds and required certain disclosures to investors.  The Act also attempted to reduce the conflicts of interest revealed in the investigations.

Over the years, the popularity of mutual funds has waxed and waned.  Mutual funds grew rapidly during the 1960s, but the number dropped precipitously after the bear market of 1969, with only 360 funds remaining in 1970.  Later, two tax law changes gave the industry a big boost.  The Individual Retirement Account (IRA) and a form of retirement plan known by the tax section which authorized it, 401 (k), provided large platforms for the sale of mutual funds to millions of Americans saving for their golden years.  Interest in mutual funds dropped again in 2003 with the revelation of wide spread scandals in which a number of funds were alleged to have  allowed their large hedge fund customers to engage in abusive trade timing practices at the expense of their smaller customers.

Memories are short on Wall Street, and the mutual fund industry has recovered since 2003.  It is reported that there were approximately 14,000 mutual funds, including money market funds, in existence in 2011.  The funds offer every sort of investment strategy in stocks, corporate bonds, government debt, gold, oil and any other investment asset you can think of.  The irony is that, year in and year out, a large percentage of the funds (some say as high as 80%) fail to meet or beat the annual performance of their respective markets as a whole.

We will look at mutual fund investing in the next post.

Comments are always welcome.