Ask the Fool: How do mutual funds work?

A. In a nutshell, a mutual fund receives money from many investors and then professional managers choose how to invest it, for a fee. Mutual funds are a great solution for those of us who don’t have the time, skill or interest to study the universe of investments and make “buy” and “sell” decisions repeatedly over long periods.

Mutual funds come in a wide variety, with some focused solely on one kind of asset, such as stocks or bonds, and some investing across several asset classes. Within the stock-fund world, funds might focus on large, medium or small companies; dividend-paying companies; fast-growing companies; or undervalued companies. Some specialize in particular industries, such as energy, healthcare or financial services; or regions, such as Europe, Latin America or Asia.

Fees vary widely by fund, and it’s well worth minimizing the fees you pay so you can maximize the growth of your money. One way is to stick with low-fee, broad-market index funds, such as those that track the S&P 500 index, or the entire U.S. or world stock markets. Those tend to have ultra-low fees, are easy to get in or out of, pay dividends and often outperform more actively managed funds with higher fees.

Learn more about mutual funds at Fool.com/investing/how-to-invest and research individual funds at Morningstar.com/funds.

Q. Can you explain what “profit-taking” is? – C.N., Tea, South Dakot

A. It’s a fancy way of referring to selling investments for a gain. If many investors are selling out of a stock after it has run up a lot, the selling will depress the stock a bit, and you might hear that the share price is down due to profit-taking.

Fool’s School

Warren Buffett Loves Dividends. You Should, Too

As you go about your financial life, it’s smart to learn from those who are great at managing money. It’s hard to top Warren Buffett for that, as shares of his company, Berkshire Hathaway, have risen in value by 2,744,062% between 1964 and 2019. That’s an average annual growth rate of over 20.4%!

One of Buffett’s wealth-building strategies is available to all of us: investing in healthy and growing dividend-paying stocks. Over decades, Buffett has bought many companies outright – such as Dairy Queen and the entire BNSF railroad network – and he’s bought portions of many other companies via shares of their stock. In Berkshire Hathaway’s 2019 annual report, Buffett listed the total dividends received just from Berkshire’s 10 largest stock holdings, which include American Express, Apple and Bank of America, and they amounted to nearly $3.8 billion. That’s cash arriving year in and year out, which Buffett can reinvest in more companies or stock, building Berkshire’s wealth further.

Consider just one of those stocks: Coca-Cola. Berkshire Hathaway owned 400 million shares – 9.3% of the whole company – as of the end of 2019, a stake worth $22.1 billion at that time. Buffett noted that the cost to acquire those shares over time was $1.3 billion. That alone reflects a great gain, but remember the dividends: Berkshire’s shares of Coca-Cola entitled it to about $640 million in dividends in 2019 alone (up from $624 million in 2018). And the company has owned shares in Coca-Cola for many years, collecting dividends all along. Just a few recent years’ worth of dividends earned back the entire price paid for the shares.

You may enjoy similar results, on a smaller scale, if you park money in some great dividend-paying stocks. Favor companies that are increasing their payouts briskly, and those generating plenty of cash for dividend payments. Check out our “Total Income” service at Fool.com/services to see some stocks we recommend. Or just opt for a dividend-focused fund or two, such as the Schwab U.S. Dividend Equity ETF (SCHD) or the Vanguard High Dividend Yield ETF (VYM).

My Smartest Investment

Learning and earning

My smartest investment has been my education. After all, education is the one thing that can’t be taken away from you. – S.C., online

The Fool responds: With college costs soaring in recent decades, some have come to question the value of higher education, arguing that massive student-loan debt isn’t worth it, and that many jobs don’t require college degrees. On the other hand, various studies show that those with college degrees earn more, on average, than those without. A recent study by the Federal Reserve Bank of New York cited a “college wage premium” of nearly 75%, with the average college grad (with just a bachelor’s degree) earning roughly $78,000 annually, compared with $45,000 for someone with only a high-school diploma.

That said, there are other factors to consider, such as what you study, because the major and profession you choose will make a big difference. Doing well in school can lead to better job prospects, and the school that you go to can matter, too. It’s worth studying colleges and careers before sending in any applications – favor schools, degrees and careers that are likely to be satisfying and that pay you enough to live on. Keep student-loan debt to a minimum by seeking out and applying for scholarships and financial aid – there’s more help out there than many people realize. For best results, keep learning throughout your life.

Foolish Trivia

Name that company

I trace my roots back to a one-bedroom apartment in San Francisco, where four guys began developing cloud-based customer-relationship management software in 1999. By 2001, I had more than 3,000 customers. For fiscal 2002, I had $22.4 million in revenue; by fiscal 2020, that topped $17 billion. I’ve been named one of the most admired companies and one of the best companies to work for. I’ve given more than $300 million in charitable grants, too. I employ more than 49,000 people, and 90% of Fortune 500 companies are my customers. My market value recently topped $242 billion. Who am I?

Last week’s trivia answer

I trace my roots back to 1967, when a pathology resident borrowed $500 from his father-in-law and founded Metropolitan Pathology Laboratories, performing outpatient testing in a two-room apartment in New York City. Corning Glass Works bought me in 1982, only to spin me off in 1997 with a new name. Today, with a market value recently topping $15 billion, I’m the world’s largest diagnostic information services company, serving about half the doctors and hospitals in America and over 30% of American adults annually. I employ some 47,000 people and rake in more than $7 billion annually. Who am I? (Answer: Quest Diagnostics)

The Fool Take

Under and over wear

There’s a lot to like about Hanesbrands (NYSE: HBI). For starters, it owns a portfolio of familiar brands, such as Hanes, Champion, Maidenform, Bali, Playtex, L’eggs and Wonderbra. It’s a top apparel brand in the U.S., and has the benefit of operating most of its own manufacturing facilities — unlike many of its rivals, which contract out for such work.

The company has been hurt by the pandemic, with many of its sales channels closed or ailing, though its mass-merchant channels such as Walmart and Target remained operational even during lockdown. Hanesbrands had already been struggling pre-pandemic with a soft innerwear market, and it carries significant debt (around $4 billion), far eclipsing its cash.

The news is not all bad, though, due in large part to its Champion activewear unit, which is performing well. In addition, Hanesbrands has a new business that’s specifically pandemic-related: It began making protective face masks and gowns for the federal government, delivering more than 450 million masks and 20 million medical gowns on time. It’s also making face masks for consumers, large organizations and business-to-business customers, and this new business doesn’t look like it’s going away anytime soon.

Hanesbrands stock may not double or triple in the near future, but it’s positioned to reward long-term investors over time. Its dividend, recently yielding 3.5%, is a bonus.