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What is a Mutual Fund and Why Should You Invest In Them Instead of Individual Stocks?

What does this salad have to do with investing in mutual fund? Diversification!

When I go to Whole Foods, the thing that is most tempting to me is the salad bar.  What is not so tempting?  The price! So I have to be very judicious in my choices or my salad will end up weighing as much as my size 11 shoes (yes, really size 11) and I will end up with a $92 lunch.  There are lovely quinoa edamame melanges and shredded beets and squash en vinaigrette.  How do I know which one I will like?  If I filled up my box with only a couple of salads, and I don't like either of them, I will be disappointed and hungry. So, I came up with a strategy to increase the odds that I find at least half of my purchase tasty. I take one tablespoon of 10 or 12 of the salads.

The same strategy can be applied to investing.  If I were to choose only four stocks and 1/2 of them go down, I will suffer a much larger loss than if I buy 20 different ones and half of them go down.  But how do you know which 20 to buy?  That is pretty tricky. That's why mutual funds are the perfect investment solution.  It's getting a little taste of at least 20 stocks without the likelihood that they will all tank but with the potential for increasing in value.

When I was around 16 or 17 years old, my parents were very into owning Polaroid stock. My parents met in Cambridge, Mass where the company Polaroid was established, And, at one time, it was a very good stock.  It made a really cool camera.  Having a Polaroid camera was like owning an iPhone when everyone still had flip phones.

I could only dream of having a Polaroid camera.  I had a camera that used flash cubes. This was advanced technology at the time because I could take four different shots with one four-bulb flash cube without having to reload. This was a huge upgrade for me;  my previous camera was one that could accommodate only one flash bulb at a time. And you had to wait for it to cool off to replace it with the next one for a second shot. Yes, I am from the stone age.  Half of you have no idea what I am talking about.  

(A bit more background on my underprivileged upbringing in suburban Connecticut:  You should know that we also had no photo albums in our home; we had only slides. They were cheaper than prints. For a treat, my parents would entertain my siblings and me with slide show night:  their projector could handle one manually loaded slide at a time.  It could take all night to get through one box of 20 slides.  Especially when they were accidentally loaded upside down and had to be reloaded. Needless to say, we were awestruck when our folks finally got a new fangled projector with carousels where you could load up to 100 slides at a time!  This was almost as exciting as when we got our first color TV when I was 16 years old.  It was 12 inches.  We were thrilled!  We no longer had to be farmed out to other more fortunate color-TV owning families each year on the one night that the Wizard of Oz aired.  You know, so we could actually see that the Yellow Brick Road wasn't gray.

As you can imagine, a Polaroid camera was like magic to us and completely unattainable.  My parents loved the stock. I had just taken a high school economics class where we learned about the stock market.  I figured my parents knew what they were doing.  Didn't all parents?

But like anyone else who purchases one stock, they were gambling.  But, of course, I didn't know that.  I asked my parents to buy me $250 of Polaroid stock thinking I would get rich.  $250 back then was a lot of money.  I used to make $1/hour babysitting so you can imagine how many bedtime stories and diaper changes were involved for me to come up with that kind of money. Well, let's just say that I would have been better off keeping my money under my mattress. I never saw that money again. I never bought an individual stock again!  It was just gambling.

I had one more lesson on gambling.  My Dad took my brother, my two step siblings and me, all of us in our late teens, to a casino in Atlantic City.  He gave us each a roll of quarters and told us to do whatever we wanted with it. Well, we all played the slot machines.  We all lost everything. This took about 10 minutes.  We went home.  We might have gotten Carvel first. I can't remember. Moral of the story: none of us ever bought an INDIVIDUAL stock after that. That was the best $40 investment my Dad ever made.

DON'T BUY INDIVIDUAL STOCKS unless you can afford to lose that money.  The risk is too great!  Instead, John Bogle, the father of index funds and founder of Vanguard preached this philosophy:

"The heavy risk of owning individual stocks can be limited by owning the whole stock market.  This way you eliminate both the risk of holding a particular market sector and the risk of hiring an investment manager who fails us." I do love Vanguard's Total Stock Market Index Fund. It made 30% last year! It has 3555 stocks in it! Now that's diversification!


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