Suppose that you decide that you want to begin investing for retirement. You would probably want to hold some money in a diversified portfolio of stocks. You might want to put some money in bonds. You might even want to hold stock in some foreign companies. Now suppose your budget will only let you invest $25 per week. How are you going to build this retirement fund? You will probably not want to buy individual stocks, and with only $25 to spend at a time, you will not be able to buy bonds. The solution to your problem is to invest in mutual funds. Mutual funds pool the resources of many small investors by selling them shares in the fund and using the proceeds to buy securities. Through the asset transformation process of issuing shares in small denominations and buying large blocks of securities, mutual funds can take advantage of volume discounts on brokerage commissions and can purchase diversified portfolios of securities. Mutual funds allow small investors to obtain the benefits of lower transaction costs in purchasing securities and to take advantage of a reduction in risk by diversifying their portfolios. In this chapter we will study why mutual funds have become so popular in recent years, the types of mutual funds, how mutual funds are regulated, and finally, how conflicts of interest in the mutual fund industry have led to many scandals, fines, and indictments since 2001.
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