[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

regarding the prospects of the economy, the industry, and that particular firm. Loss
of faith in any one of these could lead to a drop in the stock price. Thus, an individual
who has to sell all his shares because of some medical emergency might find
they have declined significantly in value. Even if the investor believes that the shares
will eventually return to a higher value, he may be unable to wait.
Shares of stock are riskier than corporate bonds. When a firm goes bankrupt
and must pay off its investors, the law requires bondholders to be paid off as fully as
possible before shareholders receive any money at all. As a result, a bondholder in
a bankrupt company is likely to be paid some share of her original investment, while
a shareholder may receive nothing. But over the long run, shares of stock have
yielded very high returns. While corporate bonds yielded on average an annual real
rate of return of 2 percent in the period from 1926 to 2003, shares of stock in the
same period yielded a real return of nearly 10 percent.
MUTUAL FUNDS
A mutual fund gathers funds from many different investors into a single large pool
of funds, with which it can then purchase a large number of assets. A money market
mutual fund invests its funds in CDs and comparably safe assets.
The advantage of a money market mutual fund is that it offers both higher rates
of interest than bank accounts and high liquidity. The fund managers know that
most individuals will leave their money in the account, and some will be adding
money to the account as others pull money out. They are thus able to put a large
proportion of the fund in certificates of deposits and still not have to pay the penalties
for early withdrawal. In this way, money market mutual funds give investors
the easy access to their funds associated with banks, while providing them the higher
return associated with CDs.
Money market mutual funds may also invest their customers’ money in short-term
government bonds, called Treasury bills, or T-bills. Treasury bills are available
only in large denominations ($10,000 or more). They promise to repay a certain
amount (their face value, say, $10,000) in a relatively short period, less than 90 or 180
days, and investors buy them at less than their face value. The difference between
the amount paid and the face value becomes the return to the purchaser.
With most money market mutual funds, you can even write a limited number of
checks a month against your account. The major disadvantages of mutual funds are
that they may require that you maintain a high minimum balance in your account and
they may not be insured by the federal government. However, some money market
funds invest only in government securities or government-insured securities, making
them virtually as safe as bank accounts.
Other mutual funds invest in stocks and bonds. Typically, they buy stock or bonds
in dozens, sometimes hundreds, of different companies. Investors recognize the
advantage of diversification—of not putting all their eggs in the same basket. If
you put all your savings into a single stock and that firm has a bad year, you’ll suffer
a large loss. If you own stock in two companies, losses in one company may offset
gains in the other. Mutual funds, in effect, allow much broader diversification.
Of course, if the whole stock market does badly, a stock mutual fund will suffer
INVESTMENT ALTERNATIVES ∂ 869