A mutual fund is an investment company that pools funds from investors in the form of share offerings. Each share represents an investor’s proportionate ownership of the fund’s holdings and income they generate. The fund then invests in stocks, bonds, and/or short-term money market instruments. A professional fund manager decides which investments a fund will make. An investment in a mutual fund is subject to the risks of the portfolio of securities held by the fund. Most funds will have an investment objective that the fund manager seeks to achieve.
The securities holdings of the fund are referred to as its portfolio. Mutual funds are typically open-ended, meaning that the fund offers an unlimited amount of shares which are priced according to the net asset value (NAV) of the fund. (NAV is the value of an entity’s assets less the value of its liabilities.) The fund is also managed by an investment adviser. Shares in a mutual fund are generally liquid, allowing shareholders to redeem their shares at any time—depending on the fund. Fees associated with the purchase of shares in a mutual fund include broker commissions, operating expenses charged by the fund and taken out of the fund’s assets, and redemption fees when the shares are sold back to the fund. Most funds also offer break-point discounts, which incentivize larger investments in the fund by reducing the amount of commissions an investor must pay as the amount of the investment increases. Mutual funds are also characterized by the classes of shares they offer—A, B, or C—which vary based on fees and expenses the fund charges.
Mutual funds are typically suitable for an investor looking for increased diversification, daily liquidity (depending on the type of fund), investments that are managed by a professional, the ability to invest in securities that may be available only to larger investors, government oversight, and ease of comparison. Some drawbacks of mutual funds include fees for professional services, less control over the timing and recognition of gains for tax purposes, limited ability to predict income, and a limited ability to customize an investment portfolio on an individual basis.
Fixed-Income Mutual Funds
Fixed income funds are mutual funds that invest in debt instruments – typically, bonds. As with equity-based mutual funds, fixed income funds offer investors the opportunity to invest in a diverse portfolio of securities. Fixed income funds invest in income-producing bonds, selected by a professional asset manager. Most fixed income funds seek to provide its shareholders with income on a regular basis. The risk of investing in a fixed income fund varies with the creditworthiness of the bonds in the fund’s portfolio. A fixed income fund may invest in anything from U.S. Treasury bonds (very safe) to corporate junk bonds (very risky) and even international bonds (bonds issued in a foreign country). The prospectus for a particular fixed income fund provides information on the objectives of that fund. Fixed income funds also have varying fees and expenses that can affect an investor’s return. The performance of a fixed income fund is subject to credit risk (the risk of default by the issuer of the securities held in the fund’s portfolio) and market risk (the risk that general market conditions will diminish the value of the securities held in the fund’s portfolio).
A closed-end fund is not a mutual fund; rather, it is an investment company that offers a limited number of shares in an initial public offering which are then traded on an exchange. The value of a closed-end fund is determined by supply and demand in the market as well as by changes in the value of the securities held in the fund. Shares of a closed-end fund trade at either a premium or discount to the net asset value (NAV) of the fund. (NAV is the value of an entity’s assets less the value of its liabilities.) Like open-end (mutual) funds, professional asset managers buy and sell the securities held in closed-end funds, which typically concentrate on a specific industry, geographic market, or sector. Closed-end funds also carry management fees and other expenses which can affect investment return.