Mutual funds have been very popular, but do investors really know how do mutual funds work?  Even in hard economic times, mutual funds are still one of the most popular investments on the market today, mainly as a result of retirement funds. For example, there are more than 10,000 different mutual funds available on the market to choose from.

There are many reasons for their popularity, but it could be due to historically good returns, or that they are easy to buy and sell. With the billions flowing into 401(K) accounts, mutual funds also gain the lion’s share of such investment. They also offer a way to diversify and dilute risk.

Here’s how mutual funds work:  A mutual fund takes money from investors looking to invest in stocks, bonds, or a variety of other securities. It is basically a conglomeration of multiple individual investments. As this grouping of investments gains or loses value, investors will gain or lose also. When a mutual fund pays dividends, the investor receives his or her share. Mutual funds are professionally managed, and because of the variety of investments, can help investors be diversified. Investors have been led to believe for some time that mutual funds can do a large part of the investing work for an investor.

As for the business side, a mutual fund is a company that pools money from many investors and then invests the total on behalf of the group, in compliance with a specific set of investment goals. Mutual funds raise their money by selling shares of the fund to the public, in the same way that a company sells ownership shares of stock. It is this pool of funds that the fund company will use to make various investments, using vehicles such as stocks, bonds, and money market instruments.

When a shareholder purchases a share in a fund, they receive an equity position in the fund and, by extension, a share of each of the fund’s underlying securities. Usually, shareholders may sell any or all of their shares at any time, but as with other investments, the price of a share will change daily, based on the performance of the underlying securities in the fund.

When choosing a mutual fund, you should keep in mind your personal financial plan and goals. To start, don’t just rely on features such as past mutual fund performance - these do not reflect future performance in any way as many have learned the hard way today. Instead, start by determining your financial priorities, what financial resources you have, how you consider investment diversification, your feeling about how much risk to assume, and what your time horizon is for your investment goals.

If you only look at total returns you are seeing only half the story. Mutual fund returns show past performance, but even if the returns are high, are they competitive with the market for comparable investments? And will it necessarily reflect how a fund will do in a poor market if the returns have been gained only during up years? You should do your research into the underlying investments, fees, and performance before assuming a good total return means the fund is a quality investment. be sure to compare it to other similar funds over the same period. Using research, you can find what are the top mutual funds for your investment style and goals.

As it is often said, past performance can’t predict future results. After the recent downturn in the market, it’s clear that ever-rising values have hit the wall. It’s not certain either when or if the market will return to consistent growth. So, it is becoming all the more important to understand how mutual funds work, what the underlying investments are, and how they can fit into your long term investment plan given the current market conditions.

When your retirement money is invested in a really bad market, the first thing you want to do is think about reallocating. Reallocating means changing the portions of your money you have invested in each mutual fund. As you have seen, your 401(K) provider probably lists suggested allocations for your portfolio based on your age, and consists of what percentage your money should be in stocks, what percentage in bonds, and sometimes they tell you a percentage of your 401(K) to put in cash.

But these percentages go out the window in a recession or depression, because you want safety no matter when you are retiring. For the past year, stock prices have plunged. The allocations are probably wrong for your particular risk appetite. And if you call your 401(K) provider or employer, as I have, they will probably tell you, “Stay invested!” or “We feel the allocations are appropriate.”
Well, they really just don’t want you to move your money!

No, you have to learn how to reallocate your stocks on your own – based on a new market, and wait until things change or get better. There is no reason to stay in losing funds when you can reallocate to wait until a change for the better.

Now if you’re thinking of putting your 401(K) into cash, you should understand that that doesn’t not mean taking your money out of your retirement account. this could incur penalties that total a large percentage of your money – so don’t add penalties to your losses.

When you invest in your 401(K) instead put it into cash vehicles. Your broker will offer at least one or two of these accounts, since their plan allows for older workers nearing retirement to move into safer investments. These are the investments you want to take advantage of for now.

For example, if your broker offers a sample portfolio balance for someone within 3-4 years of retiring, use that for the their safest vehicles. some of these might be bond funds (usually government bonds), and some will be savings or money market options.

If you don’t want to take their advice, then see what funds or accounts they do offer, and move the portion of your money you want to protect into these vehicles. this is the way to move your 401(K) into cash, not by withdrawing all of your money. Then as the market slowly gets better, start moving small percentages back to stocks, based on the performance of the stock market. This is the beast way to use cash n your 401(K).

With the market crash from 2008-2009, one could ask, are hedge funds finished? The quick answer to the question is “hardly”. There is no general definition of what is a hedge fund. In the beginning, hedge funds would help “hedge” investments by selling short the stock market, and so providing protection against volatility in the stock market. But now, the term is used more broadly to describe any kind of private investment partnership.

Globally, there are thousands of different hedge funds operating. Their main goal is of course to make lots of money, and to do so by investing in a variety of different investments and investments strategies. Often the strategies used are more aggressive than than the investment strategies of standard mutual funds.

Generally, a hedge fund operates as a private investment fund. The fund’s general partner selects different investments and also manages the trading activity and everyday operations of the fund. The investors or limited partners will invest much of the money and share in the gains of the fund. The general manager often charges a small management fee and earns a large incentive-based bonus if the investments earn a high rate of return.

While this might sound like a mutual fund, there are some important differences between mutual funds and hedge funds:

1. Mutual funds are managed by mutual fund or investment companies and are quite heavily regulated by federal law. Hedge funds, since they are private funds, have (so far) fewer restrictions and regulations.

2. Mutual fund companies invest only their client’s money, but hedge funds can invest their client’s money as well as their own money in the underlying investments.

3. Hedge funds charge their clients a performance bonus, usually equal to 20% percent of the gains above a certain floor amount. This is in line with equity market returns. Some hedge funds have successfully generated annual rates returns of 50% or more, even during volatile or difficult market environments. A mutual fund return is usually not as high.

4. Mutual funds have disclosure requirements, as well as other prohibitions against investing in derivative products, such as using leverage, short selling, taking too large a position in one investment, or investing in commodities. Hedge funds however may invest client funds however they wish.

5. Hedge funds are restricted from soliciting investments, and this is why you hear very little about these funds. During the five years prior to September 2008, some of these funds have doubled, tripled, or even quadrupled in value or higher. However, it’s important to remmeber that hedge funds do incur large risks and in this difficult economy, many funds will likely disappear after losing big.

Hedge funds are just another way to protect wealth, but in a tough economic environment, it’s likely that some restrictions will be imposed in the future.

You probably know where the term “con” comes from – as in, to “con” someone, or a “con game”.  It is short for “confidence”.  By gaining your confidence, someone rips you off.

That’s what we’re seeing right now. People are afraid. They do not feel confident – confident that they will keep their jobs, confident that they will keep their homes, confident that their retirement investments will be there when they are old.

Television, web sites, financial advisers, the analysts on Wall Street, the Wall Street bankers – all are playing a huge confidence game, and we, the investing public, are their victims.  These vultures have really benefited, ever since the 401(K) really took off, and it was clear that regular Americans, now deprived of pensions and other ways to retire comfortably, would just shovel money in without really  knowing anything at all about wise investing, on the promise that “over time, the market returns 8%-10%-14%” you name a figure.  The whole thing has been a con.

But really, what I wanted to talk about is confidence, and how to regain it.  Think:  What would it be like to feel confident that your money was safe, right now?  Think of the stress that would be off your shoulders.  Think of how you would breathe easier, knowing that whatever the market was doing, up or down, you are in a secure position, not losing, not having to learn more than you have time to learn, or more than you can understand.  Not know what the heck to do as you watch the market numbers go down.

What would it take to feel confident that your money was safe?  A friend of mine was completely freaked out, and kept asking me, What should I do with my retirement accounts? (This was last November, she was down 15%.)  I told her I thought the markets would keep going down, for some time, but that was just my opinion, and she needed to do what she felt was safe.

Her adviser (who was completely ripping her off in fees by the way, but she didn’t know that) kept saying “Oh no, you are in for the long term, don’t worry about blips in the market.”

Yet when I looked at my friend, all I saw was worry!  She kept saying she hated the markets, hated having to think about being in stocks.  She did not like the stock market, did not like that she couldn’t understand it.  Her confidence was shattered, and so was her emotional well-being.

I asked her:  Given how you feel right now, are you willing to bet what money you have left that not only will the markets stop going down, but that they will go up enough in one year to recoup what you’ve already lost?  Her answer was no.

I said to her:  If you are this uncomfortable in the stock market, take your money out!  Get this monkey off your back!  You can earn small but secure returns in money markets, CDs, and even learn later about government bonds or other less risky investments.  Will you earn 8%, 10%, 12%?  No, but that is never a sure thing anyway.

She moved all of her accounts to money market funds.  Her relief was palpable. She could breathe again!  She did not have to spend day in and day out worrying and watching tee vee, watching her hard word slip away from her.  Today, she feels a whole lot better for sure that she’s missed the downturn in the last 4-5 months as well.

If you feel insecure being invested in stocks, if you do not have confidence that  your money is in a secure place – then move it. Now. Today.  If your advisor tried to talk you out of that, remember that they have a vested interest in getting fees from you.  Move your money out of their claws.  Your gut is at least as accurate as any investor – including me!  No one has any answers in a market – possibly a depression – like this.

In case you care, and I’m not saying you should do any of this, here’s what I would do, and actually is what I am doing right now:

Move your money to a high-interest savings account.  ING Direct is a good one, and if you also open chekcing, you can access your money wit a debit card.  High Interest these days is just under 2%, but would you rather make 2% or lose 25%?

One your money is safe, then learn about what is out there that is cash or cash-like, and then move some money into those accounts. For example, there are government bond mutual funds like GNMA, or inflation-adjusted bond funds or ETFs where you can invest, and earn a few more points, and your money is relatively safe.  Note:  Funds and ETFs are not insured accounts. For FDIC insurance, you shoudl be in a money market, or CD, and verify it is insured with the institution.

You can then take some money out of savings, and open accounts with a low-cost broker like TradeKing.  Buy into some of those cash-type vehicles through these low fee brokers.

Once you are securely set there, you can explore other ideas, like buying some gold or silver, or some commodities, or buying stocks in foreign countries like China, which are available as ETFs or within a fund.  (I prefer ETFs but more on that another time.)

I also only put the company match into my 401(K).  I put extra money into a ROTH and Individual IRA outside my company, into a self-directed brokerage account, where I can decide for myself where to invest my money – I’m not stuck with the investments and rules my employer decides is right for me. They’ve already proven they have no idea how to protect my retirement interests.

The bottom line is, you need to restore your own confidence.  The so-called advisors are not going to help you.  Television is not going to help you.  If you are scared, fearful, anxious, take steps NOW to remove that stress from your life.

Your money can in fact be safe, and there are in fact places to invest where you can make money right now.  Just not in the ways that the con men will tell you about.