Shopping Funds By Price Fruitless Supply And Demand Does Not Affect Market As It Does For Stocks

As much as you want to look for good value when you go shopping for mutual funds, there’s not much point in worrying about the price.

That statement may sound strange to people who don’t have much experience investing in funds. In the world of consumer goods, and indeed with most other types of investments, it’s always important to be price-conscious when you buy.

But in the unique system under which open-ended mutual funds operate, the price per share has absolutely no bearing on the results you can expect, and no significance at all in comparing one fund to another.

This basic issue comes up dozens of times every week in phone inquiries to the Janus fund family in Denver, reports Lorrie Grove, public relations manager at the $67 billion money-management firm.

“It usually begins with callers wanting information on a few funds they are considering as possible investments,” she says. “After hearing the share price of a fund with a higher net asset value, sometimes they will literally say, ‘That’s too expensive. Do you have anything cheaper?”’

To understand why this kind of thinking is misguided, visualize a mutual fund with a portfolio of investments worth, say, $1 million as a pie to be sliced up and owned in pieces by individual shareholders.

You could divide the pie into 100,000 pieces, priced at $10 apiece, or 50,000 pieces, priced at $20 apiece. Either way, an investment of $10,000 would make you an owner of 1 percent of the fund, whether it bought you 1,000 or 500 shares.

And if the portfolio as a whole rose $50,000, or 5 percent in value, your $10,000 piece would gain $500, or 5 percent as well. That would be true whether your initial investment was stated as 1,000 shares at $10 or 500 shares at $20 - or 200 shares at $50, or one share at $10,000, for that matter. It’s the percentage change that counts.

This same logic pertains, by the way, to stocks of individual companies. That’s why the seeming benefit of a stock split, in which holders get twice as many shares as before and the price per share is halved, is really illusory.

But a split may still stimulate demand for a company’s stock by making it easier to buy a “round lot” (the customary unit of trading) of 100 shares - especially if the split is accompanied, as many are, by an increase in the cash dividend and an optimistic forecast from management.

In the case of a mutual fund, however, the price isn’t determined by supply and demand for shares. And since you aren’t going to buy or sell your shares in the open market, it doesn’t matter whether you own a round lot, or even a whole number of shares.

The daily price at which all buy and sell transactions take place is based on the net asset value (NAV) per share, computed by adding up the market value of all the fund’s investments and dividing the sum by the number of shares outstanding.

In the absence of supply and demand pressures, the price can never go to a premium above or a discount below net asset value, as happens routinely with closed-end funds whose shares are traded just like industrial stocks.

So there is no way to try to bargain-hunt for cheap shares of a standard open-ended fund, or to look for opportunities to sell at overpriced levels. That’s why you seldom see people keeping charts of the price fluctuations of open-ended funds, or studying such other technical information as professional investors’ buying and selling of a fund’s shares.

At this time of year, notes Ms. Grove, many people wait to make new investments in fund shares until after yearend capital gains distributions are made.

Some do this for good tax reasons. But others, she says, take that approach “because the share price of the fund drops following the distribution and allows them to buy more shares. They fail to realize that their gains from that point on are determined by the percentage gain. The share price doesn’t matter at all.”