Mutual funds, more accurately known as Investment Companies, are a wonderful diversification tool for the smaller investor since they serve as pooled funds where many investors can take advantage of small minimum investments and professional management.
If you need a refresher on the different types of mutual funds, costs and other mutual fund basics, the Mutual Fund Basics tutorial will be helpful.
Classes of Mutual Funds
Mutual funds are regulated under the Investment Company Act of 1940 and are classified as one of four types:
- Unit Investment Trusts (UITs) - a pool of unmanaged investments where a fixed portfolio of income-producing securities are purchased and held to maturity; UITs typically invest in corporate or government bonds or mortgages. Units in the trust usually are sold to the public at a price of $1,000 per unit.
- Face-amount certificates - essentially function like a bond, where the issuer pays coupons until maturity and pays the holder the face value at maturity or a surrender value if the certificate is presented prior to maturity
- Closed-end management companies - where a mutual fund issues a fixed number of shares, which are then traded in the secondary market (usually on a major stock exchange). After the shares are first issued, the investor must buy closed-end shares from another investor on the open market, not from the investment company. The value of shares is determined by supply and demand, meaning they may trade at a discount or premium to the Net Asset Value of the fund.
- Open-end management companies - most mutual funds are open ended. Investors buy or sell units at the fund's current Net Asset Value, or NAV. The number of shares outstanding depends on investor demand. When an investor wishes to purchases shares in an open-end fund, the fund issues new shares. When an investor sells shares, the number of outstanding shares is reduced. Open-end shares are bought and sold at the NAV (plus any sales load that may apply). The NAV is calculated daily - usually at the end of the day after markets close - by subtracting total liabilities from total assets and dividing by the number of outstanding shares.
Mutual Fund Benefits and Types
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