A:

Mutual funds have been in existence since 1924, when the first open-ended mutual fund was created. Since then, the market has grown from having less than $10 million in combined assets to having nearly $10 trillion in combined assets in 2006. Mutual funds are a well-diversified portfolio of investments that include equities, bonds and other securities. Mutual funds have become increasingly popular among investors saving for retirement because of the low risk that they carry, along with their reputation of providing consistently positive long-term returns.

Under the broad category of mutual funds there are three main types, open-end funds, closed-end funds and exchange traded funds (ETFs). The value of a fund is quoted as the net asset value (NAV) of the fund. The NAV for a fund is calculated by taking the total assets of the fund and deducting the total liabilities of the fund. NAV is usually divided by the total shares outstanding for the fund, resulting in NAV per share. This per-share value is, in essence, the price investors must pay for the mutual fund.

In open-end funds, the NAV per share is recalculated at the close of every trading day. This is done because the value of the assets and liabilities underlying the funds are constantly changing. Closed-end funds usually trade at a premium or discount to their NAVs. There are three reasons why this may occur: pressure of supply and demand, fund management and expectation of asset performance. Just like stocks, shares of ETFs are bought and sold in the secondary market every day. Subsequently, the price of an ETF will change throughout the trading day.

When your mutual fund takes a profit, you are realizing capital gains on your investments. When this occurs, all of the capital gains earned on the investment are distributed among the investors in the fund. Because the fund has sold some of its underlying stock and has paid out all of the capital gains to investors, its total assets will decrease. Finally, when the assets of the fund decreases - so does the fund's NAV per share.

To learn more, see the Mutual Fund Basics Tutorial, The ABCs of Mutual Fund Classes and The Truth Behind Mutual Fund Returns.

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