One of my favorite games at my hometown’s fair is the “Cupcake Wheel”. For a quarter you can buy a square on the board. They spin a big wheel with corresponding numbers on it and if the wheel ends on your number you win a box of homemade cupcakes!
I remember one year they had more than enough cupcakes to go around so they allowed me to buy the entire board, guaranteeing that I would win my coveted box of cupcakes. Rather than choosing only one or two squares and risk that neither would be the winning square, I put my money on all of them. You could say that I spread my risk or diversified!
In the world of investing there are no guarantees and you can’t eliminate all risk. However, diversification is a powerful strategy in both mitigating risk and increasing your opportunity for growth. Much like putting my money on every square got me my box of cupcakes, spreading your money among various investment opportunities will, on average, provide a better investment return than selecting only one individual investment.
It’s against the rules of the “Cupcake Wheel” to allow me to buy the entire board. It is a game of chance after all, and the objective is to raise money for the local firemen. The more squares I have to buy to win, the more money is raised. This last year as I was heading over to win some cupcakes, I was discussing strategy with a family friend when she shared her strategy with me. She plays the game with some members of her family. Each of them buys the maximum number of squares allowed per individual, essentially buying the board. This guarantees that one of them will win and then they share the cupcakes. What a brilliant plan! Their individual costs are reduced, they avoid the risk of losing altogether, and they share mutually in the profits. Sound familiar? It should, a mutual fund is pretty much the same concept.
A mutual fund allows a group of investors to pool their money together and invest in several different investments. As an investor, you invest in a group of investments for a fraction of what it would cost you to buy each individual investment on your own. Not only does a mutual fund help you reduce your risk and costs, it also provides you the opportunity to share in the returns of the total portfolio, making it a powerful and popular investment tool.
