Mutual Funds
A mutual fund is a tool used for groups of people to invest their collective funds, called pools, into different types of securities products such as equities and debentures. These pools are managed by an investment advisor who endeavors to generate profits (capital gains) for the investors by investing the pool of funds in an advantageous manner. When the mutual fund makes money it is passed on to the investors as a dividend, but capital losses are not passed on.
Each mutual fund is required to produce a document, called a prospectus, that gives details on the inner workings of the fund including information about key staff, company background, investment descriptions, and more. When a company has a selection of several different mutual funds to choose from, the grouping is known as a family of funds, or more commonly, a fund family.
Investors may opt to have many different mutual funds from different fund families to create a personal portfolio of funds. Risk tolerance will often determine the asset allocation or investment mix with a given portfolio. This information helps investors decide the ratio of aggressive, moderate, or conservatively rated products to include in their personal portfolios.
Benefits
- Mutual funds allow relatively small investors to pool funds and thereby gain access to larger investment opportunities.
- It's easy to compare mutual funds due to regulatory oversight that requires standardized marketing resources.
- Since funds often hold many securities, there is inherently increased diversification.
Drawbacks
- Firms may require a minimum investment amount of $1,000 to $5,000 to begin investing in a mutual fund.
- Individual funds are able to be customized by the investor.
- There are typically several fees, from operating and distribution expenses to transaction and management fees. These fees could possibly pile up and impact earnings.
Types of Mutual Funds
- Open-end—A managed fund that allows investors to sell shares back to the fund
- Closed-end—A managed fund that does NOT allow investors to sell shares back to the fund
- Unit Investment Trusts (UIT)—Much like an open-end fund, a UIT can be sold back to the fund; but it is unmanaged, and the lifespan is limited at fund creation.
- Exchange Traded Fund (ETF)—A fund that combines aspects of closed-end and open-end funds with a variety of other trading structures
Classifications
Different fund types are named for their main objectives or the primary securities product involved. Money market funds, stock funds, and bond funds utilize their named securities instrument to invest. Other classifications include
- Index—This fund seeks to match or exceed performance of an index such as the S&P 500.
- Hybrid—This fund invests in a combination of stocks, bonds, and sometimes other mutual funds.
Terminology
- Share class—This is the offered shares of a single fund that provides distinctive combinations of fee structures that affect the net asset value (NAV) and yield of the fund. Share classes are often offered for different investor levels.
- 12b-1 fee—The annual fee paid by the fund to cover distribution expenses
- Back-end—This sales charge is paid by the investor at the time of redemption. It is deducted from the proceeds.
- Front-end—This sales charge is paid by the investor at the time of purchase. It is deducted from the invested amount.
- No-load—A fund with no front- or back-end charges and no more than a 0.25% 12b-1 fee
- Net asset value (NAV)—The current market value of the fund less its liabilities
Workplace Options. (Reviewed 2017). Mutual funds. (A. Moyer, Ed.). Raleigh, NC: Author.