The trouble with the stock market is the fact that some stocks go down even quality stocks and it is a devastating experience to pick out so-called "blue chips" such as U.S. Steel, General Motors and Standard Oil of New Jersey only to find after you have held them for a time that they have sagged in price. If they have not sagged they may just have held their own or even increased slightly, but when you, the investor, have sold, the buying commission plus the selling commission plus taxes have resulted in a net loss to you.
You might have been less fortunate than to have picked these "blue chips." You might have picked stocks in sound companies like American Motors or General Dynamics and found that you lost a substantial part of your money if you bought near the peak.
The chief means of hedging against losses on one stock is diversification. Mutual funds, or investment companies as they are sometimes called, provide essentially two safeguards that justify their existence: diversification and expert selection of stocks. They are companies whose sole function is to get together a group of stocks. The investor, by putting his money in the investment company, buys a small fraction of diverse stock holdings. When one particular stock drops, perhaps disastrously, the effect of the drop on the whole portfolio is negligible, so that the effect on the investor in the fund must also be negligible.
These investment companies have become extremely popular in the last two decades. In 1940, investment company assets in total were $1,061,548,000. At the end of 1960, they were $18,800,494,000. They rose 1671 percent.
There is another great but little stressed advantage in placing funds in investment companies. In the great bull markets of 1958-1959 and late 1960-1961 stocks rose in value with little relation to the underlying assets or even the earnings. There was little to hold up the price of the stocks except warm air. Very often after a spectacular flurry, down they came in price as rapidly as they rose.
The mutual funds sell at net asset value. You buy into the funds at the exact asset value and you sell out to the fund, not in the open market and not through an exchangeat net asset value. This net asset value does not mean the net asset value of the companies whose stocks are held by the fund. It means the market value of the securities held, but because the fund has a large combination of stocks, the risk of buying an American Motors at a peak price, which cannot be maintained, is minimized. The wild speculative fever that infects many, many stocks is thus to some extent minimized through the device of the investment company.
On the other hand the investor in an investment company cannot ride a speculative stock up to huge profits. He cannot ride a sound but enormous growth stock upa stock like American Telephone and International Business Machines.
Mutual funds have, however, gone a step further than to provide diversification and freedom from risk. They have become specialized enough to suit the differing needs of investors. It's a good idea to look into investing in a mutual fund, especially if you don't have the stomach for playing the open market. They allow you to put some money away with a good chance of a decent return, and you can drink your coffee and read the morning paper without swallowing your tie when you see a stock has dropped.