Mutual Funds

An investment company invests a pool of funds belonging to many individuals in a single portfolio of securities. In exchange for this commitment of capital, the investment company issues to each investor new shares representing his or her proportional ownership of the mutually held securities portfolio, which is commonly known as a mutual fund.

Mutual funds are classified according to whether or not they stand ready to redeem investor shares.

• An open-end mutual fund continues to sell and repurchase shares after its initial public offering. It stands ready to redeem investor shares at market value.
• A closed-end mutual fund operates like any other public firm. It is initiated through a stock offering to raise capital. Its stock trades on the regular secondary market and the market price is determined by supply and demand. A typical closed-end fund offers no further shares and does not repurchases the shares on demand (no funds can be withdrawn). Therefore, investors must trade in public secondary markets (e.g. NASDAQ) to buy or sell shares.

Various fees charged by mutual funds:

• They charge fees for their efforts of setting up funds. Sales commissions are charged at purchase (front-end load) as a percentage of the investment.
  • A load fund has sales commission charges. A load fund's offering price = NAV of the share + a sales charge (7.5 - 8% of the NAV). The NAV price is the redemption (bid) price, and the offering (ask) price equals the NAV divided by 1 minus the percent load.
  • A no-load fund imposes no initial sales charge.

• Redemption fee (back-end load). A charge to exit the fund. This discourages quick trading turnover and are set up so that the fees decline the longer the shares are held (in this case, the fees are sometimes called contingent deferred sales charges). Load funds generally charge no redemption fees.
• All mutual funds charge annual fees.

There are four types of mutual funds based on portfolio makeup.

• Money Market Funds. These funds attempt to provide current income, safety of principal, and liquidity by investing in diversified portfolios of short-term securities, such as T-bills, banker certificates of deposit, bank acceptances, and commercial paper. They generally allow holders to write checks again their account so they are essentially cash holdings for holders. However, they are not insured in the same way as bank deposits.
• Bond Mutual Funds. Bond funds concentrate on various types of bonds to generate high current income with minimal risk. Bonds held include government bonds, high-grade corporate bonds, and junk bonds.
• Stock Mutual Funds. These funds invest almost solely in common stocks. Some funds focus on growth companies while others specialize in specific industries. Different stock mutual funds can suit almost any taste or investment objective.
  There are two investment styles.
  • Passive mutual fund management is a long-term buy-and-hold strategy. Usually stocks are purchased so the portfolio's returns will track those of an index over time. The purpose is not to beat the index but to match its performance.
  • An active mutual fund management is an attempt by the fund manager to outperform a passive benchmark portfolio on a risk-adjusted basis. The management fees are usually higher and there are usually more trading activities which can cause tax consequences for investors.

• Hybrid/Balanced Funds. They diversify outside the stock market by combining common stock with fixed-income securities.