Mutual Fund Benefits
Mutual funds offer the following advantages to investors:
- Diversification - investing in mutual funds reduces risk in a portfolio, since the investor is able to own a proportional share of the many securities in each fund.
- Professional management - each mutual fund has a full-time portfolio manager, who can devote more time than most investors in deciding what securities to buy and when to sell.
- Liquidity - mutual fund shares can be sold at any time, and proceeds are usually received within a week or less.
- Flow-through of dividends and capital gains and losses - a mutual fund that distributes at least 90% of net investment income is treated as a conduit - meaning that the mutual fund itself is not taxed, and the investors report the dividends and capital gains on their personal returns. If the fund distributes at least 97% of dividends and 98% of capital gains to investors, it is not subject to tax surcharges, so this higher amount is almost always distributed.
Exam Tips and Tricks
Most of the questions on the exam are concerned with open-end management companies or mutual funds.
Mutual Fund Types
Although many people think mutual funds are always composed of common stocks, the fact is that a mutual fund can be made up of any traded securities that suit the fund's objectives. Here are some examples of different types of mutual funds:
- Stock funds - growth, value, large-cap stock, small-cap stock, international stock, sector funds
- Bond funds - corporate, government, municipal, convertible
- Money market funds - general, government, municipal
- Balanced funds - a mix of stocks and bonds, sometimes known as asset allocation funds
- Real estate funds - invest in a mix of real estate investment trusts (REITs), giving smaller investors a chance to gain exposure to the real estate sector in small amounts without high transaction costs.
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