Previously we discussed the concept of “Opportunity Cost”. If you choose to do one thing, you forgo many other choices. This “cost” is true whether it is money, time, or any other asset.

We talked about the opportunity cost of going on a ‘once in a lifetime’ 10 day trip to the 75th anniversary of D Day on Omaha Beach in the middle of our Valencia house deal. We talked about the opportunity cost of buying a classic car in 1984 for $10,000.

Here are the other 9 investment options, in (perceived) order of risk to capital:

  1. Cash
  2. US Treasury Note
  3. Bank Certificate of Deposit (CD)
  4. A Bond Mutual Fund (VBTLX – Total Bond Market Index Fund)
  5. A Stock Mutual Fund (VTSAX – Total Stock Market Index Fund)
  6. A REIT Mutual Fund (VGSLX – Vanguard REIT)
  7. Crowdfunding (a real estate play)
  8. Gold
  9. Angel Investing (investing in startup companies)

Today we are talking about Stock Mutual Funds.

First, what is a ‘Mutual Fund’?

A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers, who allocate the fund’s assets and attempt to produce capital gains or income for the fund’s investors.

Here is a practical description of Stock Mutual Funds.

Simply put, mutual funds are professionally managed investment portfolios that allow investors to pool their money together to invest in something.

It may help to think of it like this. Imagine a group of people standing around an empty bowl. They each take out a $100 bill and place it in the bowl. These people just mutually funded that bowl. It’s a mutual fund. Makes sense, right?

Now, what the money is used to invest in will tell you what kind of fund it is. If I go out and use the money to buy stock in international companies, then the fund would be an international stock mutual fund. What if I decided to buy bonds? Then it would be a bond mutual fund. See? Not that complicated!

So, a “Stock Mutual Fund” is a mutual fund that invests only in stocks, stocks are equity (ownership) of publicly traded companies:

The largest category is that of equity or stock funds. As the name implies, this sort of fund invests principally in stocks. Within this group are various subcategories. Some equity funds are named for the size of the companies they invest in: small-, mid-, or large-cap. Others are named by their investment approach: aggressive growth, income-oriented, value, and others. Equity funds are also categorized by whether they invest in domestic (U.S.) stocks or foreign equities. There are so many different types of equity funds because there are many different types of equities.

Specifically, we chose the Vanguard Fund “VTSAX – Total Stock Market Index Fund” because of the low expense ratio, see below.

Created in 1992, Vanguard Total Stock Market Index Fund is designed to provide investors with exposure to the entire U.S. equity market, including small-, mid-, and large-cap growth and value stocks. The fund’s key attributes are its low costs, broad diversification, and the potential for tax efficiency. Investors looking for a low-cost way to gain broad exposure to the U.S. stock market who are willing to accept the volatility that comes with stock market investing may wish to consider this fund as either a core equity holding or your only domestic stock fund.

Why Vanguard? Two well-known FIRE bloggers can explain it better than I can:
‘Mr. Money Mustache’ who I highly recommend for his financial insights …
…recommends Vanguard:

For most of my investing life, Vanguard was THE one-stop shop for index funds of all types. They have the lowest expense ratio and the utmost respect for their customers. In fact, the company is legally structured as an investor-owned entity, meaning its responsibility is to YOU as opposed to an outside group of shareholders. Read around all you like – the smartest investors will generally recommend Vanguard funds.

Another blogger, ‘My Money Wizard’, explains five reasons to go with Vanguard:

  1. Vanguard funds are cheap [low expense ratio]
  2. Vanguard is different – they’re owned by the investors
  3. Vanguard’s mutual funds are the most tax efficient funds in the world.
  4. Vanguard created the index fund
  5. Speaking of that Jack, he’s one of the few good guys in the world of finance

By low expense ratio we mean 0.04%. For comparison, some funds charge up to ten times as much, 0.51%. That’s why we go with Vanguard. Here’s some interesting information on the late John “Jack” Bogle who founded Vanguard and is the father of index investing.

Note that the “VTSAX – Total Stock Market Index Fund” is also available as an EFT. What is an EFT?

For our purposes, they can be considered effectively the same. But’s here is more if you are interested:

Mutual funds usually are actively managed to buy or sell assets within the fund in an attempt to beat the market and help investors profit.

ETFs are mostly passively managed, as they typically track a specific market index; they can be bought and sold like stocks.

Mutual funds tend to have higher fees and higher expense ratios than ETFs, reflecting, in part, the higher costs of being actively managed.

Where do stock mutual funds fall on the risk (perceived or real) scale. Long term, we think that stocks, especially if bought as a component of an established mutual fund (always buy Vanguard), are relatively low risk. If the economy is doing well and we do not have a general societal breakdown, companies will do well and their stock prices will appreciate, certainly in line with inflation. Why buy mutual funds and not individual stocks? Do not try it. You will lose money. Virtually no one is successful at picking individual stocks. That is the basic argument for index investing.

What is “risky” for stock funds and especially individual stocks is volatility.

This means that the price of the security can change dramatically over a short time period in either direction.

Here’s an example. Here is the value of $10,000 invested in VTSAX on January 1, 2020.

Due to COVID, by the end of March you have “lost” $2,000. Would you sell and take your losses? By August, you have made it back and more. But then in October you lose some and are just barely above the $10,000 initial investment. But you hang in and by December you have made 20%; you’re over $12,000. How do you like the roller coaster?

For the next Opportunity Cost option, we’ll look at a Real Estate Investment Fund (REIT); a mutual fund that invests only in real estate. Our choice was the “VGSLX – Vanguard REIT”.