Fund Pillars: Safety And Performance

That's essentially the proposition put before those contemplating mutual funds. And plenty have answered yes. The fund industry has grown from $134.76 billion at the end of 1980 to $11.39 trillion today. There were 546 funds in 1980. Now there are 8,023.

Why the popularity? Several reasons, having mostly to do with safety and performance:

Average annual return. Since Dec. 31, 1996, U.S. diversified stock funds tracked by Morningstar Inc. produced an average annual return of 9.37% through July 31 this year. The S&P 500, a proxy for the broad market, delivered 8.3% a year.

Say you invested $10,000 at the end of 1996 in the average U.S. diversified stock fund and let it sit. You'd have $25,797 in your account. The same investment in the S&P 500 would now be $23,263.

It gets better. Say you were a person of modest means back then and could only fork over $2,000 to get started, and could manage to pump in $2,000 each year thereafter. The average diversified fund would have compounded to $39,919, while the S&P 500 would have landed $31,737. (The returns don't reflect funds that no longer exist.)

You might be able to do better in individual stocks. But if you don't have time or are still learning the ropes, funds can keep your investment engines engaged as you gain skills.

Economies of scale. Funds typically have hundreds of millions of dollars in assets, sometimes tens of billions. So their portfolio managers can collect enough in fees to make it worth their while to provide you with a return that you at least can live with if not make you very rich. Funds can also spread other costs, such as for custodians and record keepers.

For somewhere between less than 1% to a bit over 2%, you can have a team of professionals watch over your investment.

Safe and transparent. Securities laws spell out how fund companies and managers handle your money and account for it. Custodians keep managers at arm's length. Record keepers track your buys and sells and changes in account balance.

Funds have boards of directors with varying degrees of independence. They approve the hiring of managers and fund service providers, and they're audited.

Fund holdings and performance are easy to see and compare. Funds are liquid. You can sell them any day you want.

Flexible. You can invest in a variety of funds. Stocks, bonds, money market, diversified, focused, a broad array of sectors, domestic, foreign.

Sound structure. Most funds are open-end. The term refers to the fact that they create or redeem shares each day as investors' money comes into or leaves the fund. Funds must calculate their net asset values each day. The value is determined by adding up all the cash and securities in the fund and subtracting fees. NAVs are broadly distributed to newspapers and the Internet.

Your shares in a fund represent your partial ownership of the securities and cash held in it. The managers are bound to try to increase its value and the fund's board is bound to keep the managers on task. The arrangement has worked very well for the most part. Except for a few high-profile cases, there has been scant outright fraud in the fund industry since it began and certainly since rules were tightened by the Investment Company Act of 1940.

Several cases of inappropriate late trading that came to light a few years ago are at various stages of being resolved. The schemes robbed fund shareholders of gains. Overall trust has been restored, and fund assets are at record levels.

While they are run by pros, funds vary widely. You would do well to learn as much as you can about investing so that you can find a good fund that uses sound principles. This will help you hold through a variety of market conditions.

Holding for the long term is key for success. Many investors don't make as much money as their funds' published performance. Why? They chase returns, buying after being drawn by big gains and selling after scary -- but normal -- declines.