Asset Allocation

finance. a la shmoop. what are the different types of mutual funds? alright

well first of all if you haven't watched our video on mutual funds already, well

go ahead and do that first. it was directed by Steven Spielberg and we need [mutual funds video link]

to amortize the million bucks we spent on it to hire him. is he really doing

sharknado seven now? anyway mutual funds. there are actually more of them than

there are individual stocks. and like hairstyles mutual funds are available in

a wide variety of options. why? because investors want to buy slices

and dices and combinations of stocks and bonds to fit a ludicrously large and

complex set of needs. and with the handy dandy help of computers slicing and

dicing is really easy today. there are really two categories of mutual funds.

bond funds and equity funds. and lots of them are combined as well ,like half

bonds half stocks you know the Centaurs of the finance world.

well those funds live at either end of the short term risk spectrum like here [stock spliced with bond]

and here. the short term riskiest funds are high gross mall cap companies often

technology-related little engines who could who pay no dividend and trade at

high price to earnings ratios. the least risky are short term bond funds which

live way over here like a dead body in a lake tied to a cinder block. they don't

go up much. most mutual funds live somewhere here in the middle of the pure

stock only or pure bond only ends. so what's a standard mix of stocks and

bonds in a mixed or balanced fund? well maybe 50 50 75 25 90 10 something like

that .there is no standard. so let's start with some extremes. bond funds are

shockingly just a collection of bonds. boring. they pay a bunch of interest they

come due in a wide range of eras or durations like six months in the future

to 30 years in the future to even a hundred years in the future. yep Disney

has a bunch of century bonds they famously launched along with Nicky

announcing that he was getting a bellybutton ring. note that bonds carry

many different dials that get turned from interest rates to call provisions

like how soon the bond which is in theory a 30-year bond could be called

back by the issuer if rates get cheaper in its future you know stuff like that.

well as far as dials go a duration is another

one of them. like how long until the bond comes due .well short-term bond funds

tend to be extremely safe and short in term and generally carry bonds which

come due within a year or less. and some bond funds with super short durations

like less than 90 days are for the most part considered extremely safe. and the [least risky bonds on a graph]

industry buzzword here is money market fund. and yes it's like there is a market

for money. some bond funds are able to take on a lot of risk or at least

relatively more risk than other bond funds. but generally speaking the

riskiest of the bond mutual funds is meaningfully less risky than a very

conservative safeish all equity mutual fund. and one key thing to think about

when you think of risk here there's risk of losing your money of course. debts

that are due tomorrow are relatively safe when compared with debts due 30

years from now. a lot can happen in 10,000 plus days. if you invest in a

risky equity take a stock it's not like one in a million odds it goes bankrupt.

risky equities go bankrupt all the time. but bonds yeah it really is more like [short term and long term debts compared]

one in a million kind of odds that they go fully bankrupt. if you invest in the

safest of bond funds like government bond funds which only keep Treasury

bills and notes and other forms of what they call government paper you know

things backed by The Full Faith and Credit of the US government to tax it's

hard working money earning taxpaying citizens, well you suffer what is called

inflation risk. if you only invest in super safe stuff and compound at 2% a

year when you could have taken some risk in a blend of bonds and stocks while the

risk is that your investment performance underperforms the rate of inflation we

all live under. that is if you're banking on your bank savings account and 2% or

something like that working for you when you're old, you'll never get to your

financial promised land. inflation will make your retirement savings nut worth [man complains that he may apply at McDonalds]

less and less. if you only made like 2% a year for all that time inflation might

have been 3% a year and you actually lost wealth or buying power relative to

what everything actually costs. let's jump to the perspective of taking equity

risk in just buying an all equity no bond index or mutual fund that

basically tracks the performance of the overall stock market think the S&P 500.

over long periods of time like decades the overall stock market has

historically compounded at about 10 percent a year with dividends reinvested.

but it's a hugely volatile Beast. some years the markets up 20 percent other

years it's down 10, but over time it goes up Lots. if you held only cash in a

savings account you'd be very safe but only get a 2% return over time. you'd

have paid a huge price for that safety. how much? well in fact we give up 8% a [year to year returns on a list]

year in compounding and after 27 years of saving well you end up with 1/6 the

amount you'd have saved had you taken that 8% a year extra risk. remember the

rule of 72? you divide the interest rate you're getting into 72 and that's the

number of years it takes to double. so 8 into 72 is 9 it means that in 27 years

you double your nut 3 times. got it? so equity risk is not a bad thing over time

there was a time and a place and generally speaking if you have lots and

lots of time to compound your investment well historically the stock market is a

great place to be. alright moving fully onto equities now the short-term

riskiest equity funds are generally those which invest in growth. that is

they invest in companies which generally don't pay a dividend, so there's no

cushion as to how low the stock can go if they hit a speed bump in their growth [ high risk stock companies explained]

trajectory. a given stock trading on hopes and dreams and momentum of the

promise of curing cancer can be trading at $200 a share one day only to discover

in the next day's FDA trial results that well it's only succeeding in growing

hair on the knuckles of Norwegian women. and while the next print of the stock is

closer to 10 bucks a share, so you can lose your shirt quickly on any one stock

so when you think about investing with risk spread among many long-term bets

you think about the diversity and range of investments you make when it comes to

risky stocks as being leans into growth the areas in the future of the world. so

the would be cancer curing knuckle hair growing stock is just one stock and a

big fat basket of growth stocks in a mutual fund. so don't let the fall of

just one stock and a bath of hundreds terrify you too much. and

note that we've made a big deal of short-term risk here instead of just

risk. why? because over time investing in growth stocks has been a really good

thing in America. the S&P 500 is growthie. let us gaze lovingly at what nine to ten [men do business, exchanging money]

percent of your compound growth looks like over a hundred ish years.

if you extracted the non dividend paying portion of it the growth year portion of

the S&P 500 has grown it's somewhere between twelve and fifteen percent a

year for a very long time. compare that with a median bond fund growth scenario

of four to six percent. huge gaps over time in varied investment turns yes, most

investors don't marry entirely one flavor of investment, they like to spread

the wealth between bonds and stock. almost literally. so how do you decide

between bonds and stocks? well generally speaking old people tend to lean more

toward bonds because they can't take much more risk. and young people toward

equities. yeah why well time. if you're on the way out the door, so to speak you

don't want to do anything too risky you just want to play it safe and keep a

roof over your head in your twilight years. if you're young well you've got

the luxury of taking big risks failing starting over again if need be so you [young man crashes and burns on a bicycle]

can more safely invest in equities because over time, well growth will bail

you out of mistakes. you make when you're young and in the scheme of things

investing in equities is not even in the top hundred riskiest things you'll do

when you're young. [list of risky things gets checked off]