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Gabe Nelson Financial, INC.

Registered Investment Advisor

Investments

Intro to Mutual Funds: What You Learned About Mutual Funds in High School

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For many people, mutual funds serve as an introduction to investing. But many of my new clients and prospective clients have confessed that they’ve bought mutual funds without even having an introduction to what mutual funds actually are.

In a nutshell, mutual funds enable you to purchase stocks, bonds, and other assets by pooling cash with other investors. Mutual funds are popular, especially among new or casual investors, because it’s a relatively inexpensive and easy way to diversify your portfolio and hedge against losses while reaping market gains.

But just because mutual funds are a somewhat simpler path to investing than other vehicles, doesn’t mean you shouldn’t do your research or be strategic about your mutual fund investment plan. The more you know about mutual funds, the better choices you can make. But if you’re not a financial geek like I am, I’m betting you’d like to learn about mutual fund investing in plain English like my clients.

What is a mutual fund?

A mutual fund is a portfolio of assets, such as stocks and bonds, that are managed by professionals. Large groups of securities are purchased with money pooled from groups of investors who buy into the fund.

Rather than owning individual company shares, the mutual fund investors own shares in the mutual fund company, which is in the business of buying shares in other companies, securities, or government bonds. So they do not own stock directly but rather share in the profits or losses of the mutual fund’s overall holdings.

When I first started teaching this concept to clients, I could tell that my explanation wasn’t sinking in. So I began breaking the concepts down even further and using analogies to clarify. 

If you’re not familiar with some of the terms I’ve already used, you’re not alone. So I will help you out and expand from there.

Stocks, which are also referred to as equities, represent ownership. If you own a share of Google stock, for example, you are a part-owner of Google and you are buying that stock because you want to participate in the company’s success.

Bonds are a kind of debt issued by companies looking for capital. A bond is really just a loan with lots of crazy terms. Simply put, when you buy bonds, you are the banker lending money to the company. If you were to buy a Google bond, for example, you agree to lend the company your money, and they, in turn, agree to pay you back with interest.

Now that you’re more familiar with what stocks and bonds are, let’s dive into some analogies I use to help you better understand how mutual funds work.

How Mutual Funds are Like Cookie Jars

I grew up in a true American blended family. I was an only child, my dad married into a family with four boys, and then my dad and stepmother had a daughter. With so many growing kids in the house, there were rarely any leftovers after dinner. We would come home hungry the next day, as every kid does, looking for something to eat. Since there were usually no leftovers in the fridge and we wanted something easy, we tended to reach for the cookie jar on the counter. 

Remember the cookie jar? 

Everyone had one, but in our cookie jar, you never quite knew what you were going to get. One week you might reach in and get an Oreo cookie, the next week a Nutter Butter or Chips Ahoy! And if we were really lucky, we’d find homemade chocolate chip cookies. My stepmother, Linda, did an amazing job of keeping us fed and did it on a budget, so whatever was on sale made it into the cookie jar. 

That cookie jar was like a mutual fund. 

Let’s call it a Tech Equity Fund – meaning it’s made up of stocks of tech companies. In my cookie jar analogy, the Oreo represents Google, the Nutter Butter represents Apple, the Chips Ahoy represents Facebook, and the homemade chocolate chips represent Microsoft.

When you own the cookie jar, you own a little piece of each cookie or in the case of the Tech Equity Fund  – you own a little share of each of those tech companies. This is why I compare mutual funds to cookie jars. 

But there are all kinds of shapes and sizes of cookie jars, just like there are all kinds of styles and sizes of funds. It all depends upon what type of cookies (i.e., stocks) they hold.  

Next, I will use an analogy about high school kids to explain the basics of funds in the market. 

How Mutual Funds are Like High School Kids

Remember high school? Whether you would prefer to forget it or you’d love to go back  — either way, you learned some valuable lessons about mutual funds without even realizing it. Let me explain. 

The market capitalization of a company is the market value of its outstanding shares. Smaller companies are more volatile; and although you may get a larger return on your investment, investing in small-cap companies opens you up to more risk. Large-cap funds are less risky, but with relatively lower potential gain.

Freshmen are like Small-Cap Stocks. 

Remember being a freshman in high school? It was a very volatile time. You were not yet as established as the upperclassmen and could end up going the wrong way. Small-cap funds are like freshmen because they are not as established; they could take a positive route and grow all the way to becoming a successful senior or they could fail and drop out. 

Sophomores are like Mid-Cap funds. 

When you were a sophomore, you had made it through the volatility of being a freshman and were getting into the groove of what it really took to navigate high school. Mid-cap funds are like sophomores because they are no longer volatile little pimple-faced freshmen; they are a bit more mature and a bit less risky.

Juniors are like Large-Cap funds. 

As a junior in high school, you had already established yourself. You had made it far enough that you were on the road to becoming a senior. Betting on a solid junior who has his head on straight is normally a bit less risky than choosing a sophomore or freshman.

Seniors are like Mega-Cap funds.

As we all learned, seniors rule the school. They have it all figured out better than their younger counterparts and know where they are going — on to college or another path. The same holds true, in theory, for the mega-cap companies. 

What about the foreign exchange students? They represent the international funds, which come from all over the world and could be a mix of Freshman, Sophomores, Juniors, and Seniors. They can even be combined into an international fund or specific country fund.

Mutual Fund Investing

Now that you know more about what comprises a mutual fund and the different types of funds, you can better understand mutual fund investing. Pull out your statements and take a look at your investment portfolio. What’s in your cookie jars? What kind of cookie jars do you have? Do you notice a mix of companies within an industry? A mix of industries? Are they all mid-cap? What’s under the lid?

If you need help mastering your finances so that you can create the freedom to build the life you want, you can email me at ga**@ga*****************.com or schedule a consultation appointment.

 

Gabe Nelson, CFP®, is the principal and founder Gabe Nelson Financial, Inc. (GNF) is a Registered Investment Advisory firm based in Sioux Falls, SD. GNF offers fee-based financial planning and investment advisory services to solopreneurs and self-employed professionals. Clients receive personal attention from a financial planner dedicated to helping them reach short and long term financial goals with specialized insight into the particular challenges and opportunities that arise in entrepreneurship. Gabe can be reached at 605.553.9180, via email at ga**@ga*****************.com, or on the web at gabenelsonfinancial.com.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

How to Handle Stock Market Volatility When Your Income Already Fluctuates

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In Gabe’s latest video and article, he talks about how solopreneurs can weather the stock market volatility. Watch the video below, or scroll down for the article.

There’s no question that we are in the midst of one of the most volatile times in the history of the stock market. Even if you’re not actively playing the market, your investments are riding on the combination of COVID-19 “Coronavirus” Pandemic, the Russia and Saudi Arabia Oil Price War, a pending recession, and an election year.

Many people are taking a hit as the economy adjusts to this unprecedented wave of challenges, but those of us who are self-employed or freelancing face a special set of concerns. As solopreneurs, our income already fluctuates — sometimes drastically — and depending on where you stand with clients, contracts, and cash flow, you could be sensing trouble ahead.

In times like these, our minds can go to all kinds of dark places. Not only are we dealing with uncertainty, but by the nature of our work, we’re often alone with our thoughts, which can be scary. If you’re letting your emotions get the best of you, you’re more likely to panic and hit the sell button, which is rarely the answer.

But you’re not alone if you’re freaking out, so it’s time to get a handle on what’s really causing the fear and how to face this challenge with confidence.

Why Do We Panic Sell?

Even though we know selling in panic is usually the wrong move, it’s only natural. So to avoid doing it, you’ll want to get to the bottom of why you’re taking this action. In order to understand why, you need to understand how your brain works.

Your brain is on autopilot 95% of the time and its primary job is to keep you alive. When we were cavemen roaming the earth, our brains were developed enough to keep us alive—the old “fight or flight” reaction. Research shows that the feelings and emotions of watching our money go down are similar to having to run for your life.

That’s why you want to hit sell—to do something that will get rid of that scary feeling. Essentially, you want to avoid getting eaten by a tiger and dying.

How to Avoid Panic Trading

So if panic selling is built into our DNA, how can we change our behavior when it’s no longer working in our best interest?

I have 3 steps that I go through with my clients to help calm their nerves and keep them from making poor decisions. I call them The Three Ps: Purpose, Perspective, Proceed.

Purpose – Revisit Your Purpose

What is the purpose of the money you’ve invested?

Take a moment to remind yourself why you started investing this money in the first place. Is it for retirement? A lake home purchase? College funding? Passing an inheritance down to your kids?

Once you have reminded yourself of the purpose, then ask yourself how much time you have before you need this money for its intended purpose. It’s important to know that your risk level matches your time horizon, so you have time to recover if things go south for a while.

As a rule of thumb, if you are losing sleep over it, you’re most likely taking too much risk.

I like to use a simple test on a scale of 1 to 10 — with 1 being, “don’t lose my money; I don’t care if I don’t make much, I just can’t handle losing,” and 10 being, “let her rip! I understand that I could lose money but in the long run, this sets me up to make the most money and I recognize that I have a long time horizon.”

When purpose rather than panic drives your thinking, you’re more likely to stay on track. It’s the big picture that matters most.

Perspective – Gain Perspective on What Investing Means to You

How does this money that is invested affect your lifestyle today and in the future?

I suggest you run the numbers to get a clear perspective on the true impact of keeping your money invested.

I have a client — we’ll call her Elaine — who has been frantically panicking lately. She didn’t understand what was going on and was very upset about losses in her account.

Elaine has been a client for many years and I know that, according to her financial plan, she has a pension from her corporate job prior to becoming a consultant, and her future Social Security will be more than enough to cover her monthly living expenses in retirement.

We discussed that the money she currently has invested in the market is intended for retirement and does not affect her current lifestyle. Then we talked about her 10-year time horizon and projected out the funds at a conservative rate of return.

By doing this exercise together, we found that Elaine would have more than enough income and funds during retirement and this recent volatility would not affect her lifestyle now or then. She walked away from our meeting with a new perspective on the recent “paper” losses at peace and went about living her life, focusing on her consulting business.

Are you losing actual money or ‘ghost money’ when the market goes down?

A paper loss is a loss on paper that is only realized when you sell the position in mind. One of my other clients calls it ‘ghost money’ and I like that because you never truly see the gains or losses from your investments until it comes time to use it for its intended purpose.

If you bought your house for $350,000, and we then go into a housing crisis like we had in 2008, and everyone is trying to sell their houses at the same time, there are no buyers. The supply has exceeded demand and even though you are not trying to sell your house today, your home is now valued at $275,000. It is still the same house and hasn’t gone down in value to you. But if you were to try to sell it in the down market, it would go for $275,000. That is a paper loss.

The same goes for investments in the market. They may go down in value on paper, but if you don’t sell them and they go back up like the housing and stock markets almost always do, you don’t truly have a loss. It’s just on paper.

By gaining perspective, perhaps you’ll ease your fears, or maybe you’ll realize it’s time to make some changes. But, again, it’s important to rely on rational analysis, rather than raw emotion.

Proceed – Make a Plan and Proceed

How does this money that is invested fit into your financial plan and how will you move forward?

You should be clear on your overall financial plan. Are you focused on building towards retirement? Debt liquidation or emergency savings? Are your living expenses in check?

The thing is, you need a plan in place to ensure your bases are covered and you don’t truly need the money until its intended purpose arrives, which could be 5 to 25 years down the road. So the first step is to get crystal clear on your cash position, cash flow, and debt situation.

  • What is your cash position? How much emergency savings do you have set aside?
  • What is your cash flow at this time? Do you even need the money that is invested at this time or in the near future?
  • What is your debt situation? Are you on track to be debt-free at least by the time your intended investment purpose arrives? If this is retirement money and you have 20 years until retirement, will your debts be paid off by then? What interest rates are you paying?

Without sufficient emergency savings set aside, if you think you may need the invested money in the near future, or if you’re holding debt, you could be taking too much risk. But if your plan is on track, you can make more aggressive and potentially lucrative investment decisions.

Now that you’re clear on your Purpose and Perspective, you need to take steps to move forward. The best thing to do when you’re stressed is to take action — not just any action, but productive action that will help you get closer to your goals with more peace of mind.

Rather than getting distracted by market volatility, focus on funding your SEP IRA, Solo 401k, Profit Sharing Plan, and your kids’ 529 Plans while the market is down. Look at this with a mindset of opportunity. What could you purchase to take advantage of this recent volatility? This could be a great wealth-building opportunity. Take advantage of it.

Cut your spending on frivolous things, such as unused subscriptions. And redirect that money into taking advantage of the investments being on sale. Seriously, stocks are on sale! If you found a deal on a new gadget or golf club, you’d jump on the deal, right? Now is the time to shop if you can.

While you’re at it, turn off the financial news and turn away from both TV and social media. Keep in mind, the media is there to suck you into consuming advertisements; and to keep your attention, they will breed more anxiety than anything else.

Remember, you’re a solopreneur. Tap into that entrepreneurial spirit, dive into your work, and do what you need to keep creating the life you want.

Create Peace of Mind

As a solopreneur, you’re the boss and the buck stops with you.

Getting clear on your purpose, perspective, and taking action to proceed will help to ease your mind and keep you moving forward toward creating the freedom you desire. I have created a Free 3-Step Worksheet that you can download at gabenelsonfinancial.com/resources. If you need help mastering your finances so that you can create the freedom to build the life you want, schedule a free consultation.

 

Gabe Nelson, CFP®, is the principal and founder Gabe Nelson Financial, Inc. (GNF) is a Registered Investment Advisory firm based in Sioux Falls, SD. GNF offers fee-based financial planning and investment advisory services to solopreneurs and self-employed professionals. Clients receive personal attention from a financial planner dedicated to helping them reach short and long term financial goals with specialized insight into the particular challenges and opportunities that arise in entrepreneurship. Gabe can be reached at 605.553.9180, via email at ga**@ga*****************.com, or on the web at gabenelsonfinancial.com.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.