MUTUAL FUND: WHAT IS IT?

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Chapter 13 — MUTUAL FUND: WHAT IS IT?
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MUTUAL FUND: WHAT IS IT?

MUTUAL FUND: WHAT IS IT?

A mutual fund (MF) is an investment instrument, often established by a financial advisory firm, that pools money together from multiple investors to invest in securities such as stocks and bonds or other assets. An MF is operated by professional money managers, who allocate the mutual fund's investments and attempt to produce capital gains and/or income for shareholders and investors. 

Mutual Fund

HOW DOES MUTUAL FUND WORK?

The owners of the mutual fund are the shareholders who buy shares in it. The advisory firm that manages the invested money is the board of directors that oversee the company. If the fund’s performance is unsatisfactory, the shareholders or investors can choose to hire a different advisor. Therefore, although most mutual funds are created by advisory firms, it is the shareholders who actually own it.

HOW DOES A MUTUAL FUND WORK?

The financial advisory firm charges a fee to manage the mutual fund. Because the MF is essentially a portfolio, the investors and shareholders make a return through dividends and interest payments, or through capital gains when the prices of invested securities increase. Various MF has different characteristics, investment objectives, and management styles. 

HOW DO INVESTORS EARN MONEY WITH MUTUAL FUNDS?

1. Income is earned from dividends on stocks and interest on bonds held in the portfolio. A fund pays out nearly all of the income it receives over the year to investors in the form of a distribution. Funds often give investors a choice either to receive a check for distributions or to reinvest the earnings and get more shares

2. If the fund sells securities that have increased in price, the investors are getting a capital gain. Most advisors also pass on these gains to investors in a distribution.

3. If the holdings increase in price but are not sold by the manager, the fund's shares increase in price. You can then sell your mutual fund shares for a profit in the market.

There are some advantages of mutual funds and some disadvantages that you also need to consider to decide if MF is actually for you.

CLOSED VS. OPEN-ENDED MUTUAL FUNDS 

An open-end mutual fund is “open” to new investors, and there is no set number of shares. Open-end mutual funds always stand ready to buy or sell their shares at the net asset value whenever an investor chooses to withdraw or deposit money in the fund. The net asset value is simply another term for the price of the MU. The net asset value of a mutual fund is priced according to the price and weight of the securities in the fund.

Closed-end mutual funds are “closed” to new investors. Like corporate stocks, they are generally issued only once through an initial public offering. Thus, the number of shares is set, and an investor that wishes to buy a share must find another investor in the secondary market willing to sell. Because the number of shares is set, the fund may be priced at a premium or discount depending on the supply and demand for the fund.

A load mutual fund is one that has a sales charge paid to the broker or salesperson when an investor purchases shares of the fund. The amount is usually a small percentage of the total amount invested.

A no-load mutual fund is one that is directly bought from the investment firm and does not charge this sales fee. Generally, investors should always prefer a no-load fund over a load fund.

Mutual Funds

Quiz

How are mutual funds different from individual stocks?

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Incorrect
0/76 (0%) Correct
  • 1
    Mutual funds are more liquid
  • 2
    Mutual funds are portfolios of stocks and bonds
  • 3
    Mutual funds provide better returns than stocks
  • 4
    Mutual funds are not different from stocks
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