All growth stock mutual funds are funds that do not pay dividends, but instead reinvest earnings into new or additional high growth stocks. If you are new to investing or would prefer to take a hands off approach, investing a portion of your portfolio into growth stock mutual funds is an excellent choice.
These funds purchase stocks that the fund manager believes will outperform the market in growth rates and are poised to grow quickly. Once a stock is matured, it is usually sold and the funds are invested into the next growth opportunity. In other words, the goal is to ride it to the top and sell it.
After a company matures, there is usually only moderate growth, but the tradeoff is the stock tends to be far more stable. If I have any critique of the growth stock mutual funds, is often the price of growth stocks is inflated due to these funds. Fund managers expect astronomical growth from the company, and even if the business does excellent, it is often a disappointment which makes the stock value decrease. The fund managers pay a price for this type of stock as they are betting on growth that did not take place yet.
Here is an analogy about growth stock mutual funds to drive the point home. Let’s say I open a grocery store in a town of 10,000 people and I am the only store of this kind. In this example, the market research may suggest I will convert 80% of these residents into customers. In addition, we can pick an arbitrary number to determine what each customer is worth to my bottom line; let’s go with $200 per year.
Thus, we can assume if that if everything goes as planned, my stock price will be based on profit of $1,600,000 per year or 8,000 people @ $200 per year. The fund manager will determine what the price of the stock should be once it gets the 8,000 customers and reaches the peak. Simply, if the stock is lower than the target price, he will purchase the stock.
From there, once the stock reaches the target price it has peaked. At this point the fund manager will sell the stock and then purchase stock in another company that has the same kind of growth potential.
To continue this analogy about growth stock mutual funds, let’s say that the target price is $100 per share. Or once the company reaches revenue of $1,600,000, the stock will be worth $100.
The problem begins when other fund managers and large investors do the same math as our fund manager did. Now everyone has a target price of $100 and will purchase the stock up until that point. Of course, this usually means that the target price will be well before our grocery store owner gets his 8,000 customers. Thus, we are purchasing a stock that is overvalued and selling the stock at the same time everyone else is.
The good news is most stocks are not as predictable as what we outlined above. Different fund managers will have different opinions about growth rate and when the stock has actually matured. It is these differences that keep the stock market interesting.
In a perfect world, these funds would be the best investment there is. Simply, you are getting all the profit you can out of a company, than moving onto the next one that is poised to gain value quickly. Your money will never be stagnant as you will not be investing in companies that have little growth opportunity. Again, if you wish to be a passive investor, you should have at least a percentage of your portfolio invested in growth stock mutual funds.
