When a man makes a deposit in a savings bank or joins a savings and loan association, or takes out a life-insurance pol­icy, he pools his money with that of other investors. Thus in fixed-dollar investing, the assembling of capital from many people into one pool, to be invested according to the judg­ment of an institution's management, is a long-established, widespread practice generally taken for granted by investors.

But in buying stocks, although the great majority of buyers are not out-and-out speculators, apparently most of them do harbor a little of a gambler's viewpoint. Their feeling seems to be: "I want to be my own boss. I enjoy picking my own stocks, and I know how to select them. I am just as smart as the next guy. If I want advice, I can get it easily and cheaply. So what is the sense of my paying somebody else to manage my money?" Admittedly an investment company has little attraction for a man with this viewpoint. But for an in­vestor disinterested in building up his own ego and aiming primarily at first-class, long-term results, are investment companies a help? That question this chapter aims to answer.

Advantage of a Large Fund

The more obvious advantages of investment companies rest on the mere fact that it has much more capital than any but a few individuals own.

An investor wanting to reduce the gamble in owning com­mon stock must hold stock in a good many companies. Mo­mentarily ignoring the existence of investment companies, suppose a man decides that for adequate diversification he should own stock in fifty companies, and for the companies he selects the average price per share is $30. Conceivably he could buy one share in each company at a total cost of $1,500, plus at least $300 expenses. In return for his money, the first things he gets back are fifty stock certificates, which he must keep safe. When he sells a certificate at any time in the future Uncle Sam requires that he know when he bought it and the cost. Also, in the course of a year he will receive some 200-dividend checks, for a total of perhaps $60. The whole thing sounds silly, doesn't it?
This example suggests three points about an investor's ob­taining diversification without using an investment company:

1. He must pay out at least a few thousand dollars, and not many investors start with that amount of money.



2. The expense incurred in making small, direct purchases of stock may be higher than on the same total amount bought through an investment company, especially if a buyer figures in the fees for later sale of the stock.



3. Even if an investor has capital enough to buy many times one share in each of fifty or more companies, he still takes on a lot of work in selecting and keeping track of so many companies, and in handling his certificates and divi­dends.

Another advantage of investment companies with capital in one pool is that the fund can afford to pay the salaries of a competent manager and assistants. Aside from the sales charge, most of the expense incurred in a typical investment company is the fee paid to the group responsible for keeping the fund invested. Usually this fee is fixed at a rate equivalent to 1/2 of 1 per cent of the fund's assets each year. Suppose a fund's capital is $25 million; 0.5 per cent of this is $125,000, which the fund can pay for an investment manager, his as­sistants, and his expenses. A fund far smaller than this may be able to hire a skilled manager, because he expects a rapid growth of the fund's assets, and consequently of his manage­ment fee. Or the same management organization may be in charge of more than one fund, with some of the assets of each fund invested in stock of the same companies, thus reducing the work for each fund.

It appears that in 1959 the investment companies with the best performance records are apt to have assets of at least $250 million, either in one fund or in a group under the same management.

Large size also implies maturity. It is practically impossible for an investment company to accumulate $25 million of as­sets, let alone ten times that much, until either the fund has been in existence for a good many years, or else its manage­ment group has an established reputation strong enough to draw capital rapidly into a new fund. In 1959 most of the funds, or groups of funds, with $250 million assets or more, are at least twenty-five years old. So a fund with a good performance record is apt to have age as well as size.

These comments on size may cause a reader to wonder: "How does a new investment company get started?" One answer is mat many investors are so careless that a salesman can sell them shares in a fund with neither size, age, nor reputation. Or a buyer inclined to gamble may want to "get in on the ground floor," whatever that means.

Of course, a fund can be large and still have poor or medi­ocre management. Large size merely gives a fund the oppor­tunity for a fine performance.

Simplicity

Thus far, this chapter has treated investment companies as one group. But most of these companies, and all of the larger and faster-growing ones, are now of the "open end" type, popularly labeled "mutual fund." The difference be­tween these and the "closed end" type is explained in the next chapter.

A mutual fund is easier to understand than most any other form of big-business organization. Here are some of the features of a typical company:

1. It issues only one kind of stock, and no bonds. It bor­rows only in moderate amounts, for short periods.



2. It owns practically nothing except stock issued by other corporations, plus perhaps some bonds or notes of corpora­tions or governments. The fund's only form of income is the dividends on the stock it owns, plus interest on whatever bonds or notes it holds. Its principal expense is the manage­ment fee. When expenses are subtracted from gross income, the remainder, the net income, is nearly all passed on to the fund's shareholders as income dividends. Customarily those dividends are paid in cash, probably four times a year, but a stockholder can give a fund a standing order to reinvest them in new shares.



3. From time to time a fund sells some of the stock from its portfolio. Adding together all of these sales during the year, if the amount the fund receives is larger than it paid earlier for that same stock, the fund has a capital gain, which it passes on to its shareholders as a capital-gain dividend or distribution. The fund pays this distribution in the form of new shares issued by the fund, unless a stockholder asks for cash. Thus, no matter how often a fund sells something from its portfolio, the only way this makes work for its stock­holders is that perhaps once a year they receive either cash or a certificate for additional shares.



4. For anyone wishing to invest small amounts frequent­ly, mutual funds have exceptionally convenient and varied ar­rangements. A buying plan can even be protected with life insurance. These easy payments plans are explained in another chapter. Comparable plans are available for selling shares.



5. The fee called a sales charge, included in the cost of shares in most mutual funds, is discussed in the next chapter.



6. A few mutual funds are organized as common-law trusts, under the laws of Massachusetts, and in these a share­ holder has no vote. But nearly all mutual funds are corpora­tions, and in them a shareholder has a vote for each share he owns. Except for an investor owning perhaps 5 per cent or more of all the shares issued by a company, the right to vote seems to be hardly more than a legal formality. But a stockholder, large or small, in either trust or corporation, does have a power whose importance cannot be exaggerated, and that is his right to redeem his shares for cash without explanation or advance notice.

Variety

A person with little knowledge of mutual funds is apt to as­sume that investment companies are all pretty much alike in investment policy and results; he looks at one fund, dislikes what he sees, and jumps to the conclusion that it is useless to consider other funds. He is as far off the track as if he said, "All people are alike." Of course, a mutual fund must conform to Fed­eral Government rules, but plenty of freedom remains to it.

The outstanding point of variety is that a mutual fund has practically as much choice as an individual investor has, as to which stocks and bonds to own and when to buy or sell them. A fund may invest in common stock, preferred stock, or bonds, or it may go into all three. It can have a large cash reserve or be fully invested. Among common stocks, it may favor big names or large-dividend payers or growth stocks. It may concentrate on one or a few industries, or be broadly diversified among industries. Among bonds, a fund may fa­vor high ratings or low-grade issues.

Even when two funds are agreed on investment policy, they are pretty sure to differ as to precisely which and how many stocks or bonds to own, and how much of each. Some funds are slow about selling items from their portfolio, while other funds sell freely. Aside from tax-exempt bonds, it would be hard to think of any kind of investing in stocks and bonds that is not practiced by some investment companies.

Past Performance, and Future

When a shareholder receives mail from a mutual fund, probably the more usual procedure is to glance through it in case there might be a dividend check, then to ditch the rest. Nevertheless, the prospectuses, reports to stockholders, and booklets issued by mutual funds offer exceptional opportun­ities to an investor able to understand a few figures. Giving copies of these booklets here would be a waste of book space, for a reader can obtain samples free from a broker or direct from the mutual funds.

Investment companies report to shareholders at least twice a year. Most funds make a report for each of the first three quarters of then- fiscal year, followed by a larger annual report. Each report is apt to start with a brief discussion of what the fund has accomplished recently. As to how the fund is invested, a report has a table of the stocks and bonds owned, with their market value, and another list of the items bought and sold since the previous report. In the accounting section, a report summarizes the fund's income and expenses, its assets at the close of the period, and the changes in assets during the period, including gains or losses on sales of stock it had owned.

These reports are easier to understand than those of other corporations, partly because of a mutual fund's simple organ­ization and uniform activities, but also because a fund makes an effort to explain itself to laymen, hoping thus to sell more shares of its own issue and so to increase the fund's assets.

The most important information about a mutual fund, its long-term performance record, may not be included in its prospectus or its regular reports to stockholders, but is avail­able on request. A careful investor's major question is: "If I buy shares of this fund, or if I continue to hold shares I al­ready own, what results will I get in coming years?" On no common stock or any other equity is a direct and definite answer to this question possible. But the best clue to future prospects is obtained by finding out what has happened to an assumed purchase started several years ago.

Anyone familiar with corporate stocks, aside from investment companies, knows that a company may be prosperous for a number of years; then something goes wrong, and prof­its shrink or disappear. Or in reverse, after making a poor showing, a company's profits may improve substantially. The change may be due to new management, new competitors, new products, or new methods that help or hurt the com­pany's profits. So usually, an investor must know considerable about a company besides its past record before he is well equipped to estimate its future.

But in a diversified mutual fund, the past record is a far better guide, for these reasons:

1. With a fund's assets spread among the stocks issued by fifty or more companies, it is impossible for a change in profits of any one or even of several of those companies to have much effect on the fund's total income or market value. Of course, in a general business recession, diversifica­tion will not prevent a decline in a mutual fund's income and market value. But this lasts only a few years at the most; and when general business conditions improve again, a diversified fund moves along with the procession.



2. A mutual fund is not chained to its past, as most any other established business is. If the management of a manu­facturing company decides to make a new product, it must conduct experiments, make changes in factory building and equipment, train personnel, and so on, all of which ties up alot of capital, perhaps for several years, before the company can begin to make a profit on the new product. In contrast to the manufacturer, when a mutual-fund manager decides he had better get rid of the stock of "A" Company, and replace it with "B" Company's stock, all he has to do is to arrange for a broker to sell the one stock and buy the other. A mu­tual fund has no need to hang on to a stock whose pros­pects are considered poor; and conversely, the fund has no alibi for not owning a stock if its prospects are believed to be better than some of those the fund does own.

This ability to switch promptly means that if the perform­ance record of a fund shows that it has been a good picker of stocks in the past, the chances are strong that it will do equally well from now on. Or if a fund's performance record has not been so good, probably it will continue at the same level. Occasionally a fund wakes up and improves on its old record, but with plenty of other funds available, an investor need not buy shares in a reformed fund until the improvement actually shows up in its performance record for several years.

A fund's quality cannot be judged safely from its perform­ance over too short a period of time. Perhaps five years is the shortest reasonable period, and maybe a few more years is better.

A mutual fund publishes tables of the present market value of a purchase of its shares made on certain dates in the past. It shows the results under three different conditions:

1. If a stockholder took both income and capital-gain dividends in cash;



2. If he reinvested capital gain dividends; and



3. If he reinvested both kinds of dividends in additional shares of the fund. Probably the fund publishes another table showing the market value accumulated by having invested a uniform number of dollars every month for such a period as ten years, with all dividends reinvested. These tables also show the amount of dividends for each of the three conditions just mentioned.

Unless a corporation issues stock on an open-end basis, as a mutual fund does, it cannot invite a stockholder to reinvest his dividends, or to buy more shares periodically. A mutual fund is exceptional in standing always ready to issue new shares to a buyer, or to redeem his shares when he wants cash.

How Much Skill?

For an investor desiring guidance as to when and what stocks to buy and sell, the principal available forms of more or less expert help can be grouped as follows:

1. Market opinions published in newspapers, on the radio, in a magazine, or in a "letter" issued by an advisory service.



2. Free advice from a broker, in exchange for a client's buying and selling stock through that broker.



3. Personal advice from an investment adviser, provided an investor has capital enough to justify his paying the mini­mum fee.



4. A broker or adviser, acting as an investor's agent, who does the actual investing for him.



5. The quarterly reports issued by an investment com­pany, available free of charge from a broker, that tell what stocks the company bought and sold in the previous quar­ter year. An investor can copy this action.



6. If an investor buys shares in an investment company, of course that company takes all responsibility for results.

Each of these ways of obtaining help on investing has a large following. But in the writer's opinion, the opportunity to buy shares in a mutual fund has made the other methods largely obsolete for an investor aiming at high-grade, long-term results. The main justification for this opinion lies in the performance records published by the funds, whose special significance has been discussed earlier in this chapter.

It is possible that other experts have done better than the best-managed investment companies. But in the course of much reading and several special inquiries, the writer has not located anyone else who, in offering his services to investors, publishes a long-term record of net results he has actually obtained with a diversified portfolio. And if any investment manager or adviser has done as well as the best of the mutual funds, it would seem to be worth his while to shout his record from the housetops.

A simple way for a market advisory organization to dem­onstrate their ability to match or beat the mutual funds to set up a mutual fund under their own management, as some have done. The minimum capital required for a fund, by Federal regulations, is only $100,000. But in setting up a mutual fund, an advisory firm sticks its neck out. If the fund makes a fine showing, that proves the competence of the managing firm; but if the fund fails to make a good record, the managers face the embarrassment that careful investors will take this record as a gauge of the advisory firm's lack of skill, Some prominent firms are in this position.