Mutual Funds for the Utterly Confused: African Cichlids
The fish pictured above actually does more than what we normally perceive fish as doing. Sure we know that they swim in schools. We know that they may even cooperate in hunting of smaller fish.
Because these fish usually gather in small groups, assigning tasks to support a breeding pair, the analogy of this species as a sort of homespun way of explaining municipal bond funds was too good to pass up.
Many of you who have aquariums with these types of fish know also that it is not all that simple. According to one team at Stanford, “In their natural habitat, male cichlids are constantly trying to ascend socially by beating each other up,” said study co-author Russell D. Fernald, professor of biological sciences at Stanford. “It would be really valuable for them to know in advance who to pick a fight with.”
This cooperation, much like the coordinated effort of a mutual fund - which by the way, depends on the participation of all of the shareholders for the fund’s success, meaning, as exiting shareholders head for the door, it is the remaining shareholders who must pay for that skittishness - allows the whole group to benefit. Once the group disbands, each individual fish is left more vulnerable.
Mutual funds shareholders reap benefits when the fund does well and when it hits a rough patch, it is inevitable that some shareholders will sell their shares. But when huge numbers do so - as in a panic situation - the remaining shareholders lose in numerous ways. The fund must sell shares to pay the exiting investors and if that involves selling winning stocks, the remaining shareholders will be left with the tax bill.
