Mutual funds belong to a group of financial intermediaries known as investment companies, which are in the business of collecting funds from investors and pooling them for the purpose of building a portfolio of securities according to stated objectives. They are also known as open-end investment companies. Other members of the group are closed-end investment companies (also known as closed-end funds) and unit investment trusts. In the United States, investment companies are regulated by the Securities and Exchange Commission under the Investment Company Act of 1940.
Mutual funds are generally organized as corporations or trusts, and, as such, they have a board of directors or trustees elected by the shareholders. Almost all aspects of their operations are externally managed. They engage a management company to manage the investment for a fee, generally based on a percentage of the fund's average net assets during the year. The management company may be an affiliated organization or an independent contractor. They sell their shares to investors either directly or through other firms such as broker-dealers, financial planners, employees of insurance companies, and banks. Even the day-to-day administration of a fund is carried out by an outsider, which may be the management company or an unaffiliated third party.
The management company is responsible for selecting an investment portfolio that is consistent with the objectives of the fund as stated in its prospectus and managing the portfolio in the best interest of the shareholders. The directors of the fund are responsible for overall governance of the fund; they are expected to establish procedures and review the performance of the management company and others who perform services for the fund.
Mutual funds are known as open-end investment companies because they are required to issue shares and redeem (buy back) outstanding shares upon demand. Closed-end funds, on the other hand, issue a certain number of shares but do not stand ready to buy back their own shares from investors. Their shares are traded on an exchange or in the over-the-counter market. They cannot increase or decrease their outstanding shares easily. A feature common of both mutual funds and closed-end funds is that they are managed investment companies, because they can change the composition of their portfolios by adding and deleting securities and altering the amount invested in each security. Unit investment trusts are not managed investment companies like the mutual funds because their portfolio consists of a fixed set of securities for life. They stand ready, however, to buy back their shares.
TYPES OF MUTUAL FUNDS
There are four basic types of mutual funds: money market, stock (also called equity), bond, and hybrid. This classification is based on the type and the maturity of the securities selected for investment. Money market funds invest in securities that mature in one year or less, such as Treasury bills, commercial paper, and certificates of deposits. They are often referred to as short-term funds. Stock, bond, and hybrid funds invest in long-term securities, and as such are known as long-term funds. Hybrid funds invest in a combination of stocks, bonds, and other securities. According to the Investment Company Institute (ICI), the national association of the U.S. investment company industry, there were 8,044 (7,101 long-term and 943 short-term) mutual funds in the United States and 55,528 outside the country at the end of 2004. The total investment by U.S mutual funds amounted to $6.8 trillion (stock=$4.04 trillion, bond=$808 billion, hybrid=$383 billion, money market=$1.61 trillion) and by non-U.S. funds to $3.5 trillion at the end of 1999. The total assets of U.S. mutual funds are less than the total assets of U.S. depository institutions, which stood at $7.5 trillion at the end of 1999.
Mutual funds also differ in terms of their investment objectives, as outlined in their prospectuses. The ICI classifies mutual funds into thirty-three investment objective categories. The main investment objectives within the stock funds include capital appreciation, total return, and world equity. Within each of these objectives, there are subcategories. There are two groups of bond funds: taxable bond funds and tax-free bond funds. Main categories in taxable bond funds are corporate bond funds, high-yield funds, world bond funds, government bond funds, and strategic income funds. The main tax-free bond fund categories are state municipal bond funds and national municipal bond funds. Among money market funds, there are also taxable money market funds and tax-exempt money market funds. As in the case of stock funds, many subcategories exist within each main category of bond and money market funds. In addition to these, there are specialty or sector funds, which invest in a particular segment of the securities market. Examples include biotechnology funds, small-company growth funds, technology funds, index funds, and social criteria funds.
MUTUAL FUND SHARE PRICING
By law, mutual funds are required to determine the price of their shares each business day. They release their prices the same day for publication in the next day's newspapers. Daily prices of mutual fund shares can also be obtained directly from the fund's offices or Web sites of commercial venders of financial information.
The share price represents the net asset value (NAV) per share, which is the current market value of a fund's assets net of its liabilities. The liabilities include securities purchased, but not yet paid for, accrued fees, dividends payable, and other accrued expenses. The NAV per share is obtained by dividing the NAV by the number of shares of the fund outstanding at the end of the day. A buyer of mutual fund shares pays the NAV per share plus any applicable sales load (also known as a front-end load). Sometimes, the sales load is collected when shares are redeemed and is known as a back-end load. Funds that have a sales load are known as load funds and use a sales organization to sell their shares for a fee. Funds that sell shares directly and do not have a sales load are known as no-load funds. The sales load often differs from fund to fund, and it is subject to National Association of Security Dealers (NASD) regulation. When an investor sells a share, it is the NAV that the seller usually receives. Some mutual funds may charge a redemption fee if the shares are held for less than a specified period.
BENEFITS AND COST OF INVESTING IN MUTUAL FUNDS
Mutual funds provide investors with a way to diversify their investment under professional management, which most investors may not be able to obtain on their own. Since the funds operate with a large pool of money, the investors benefit from economies of scale, such as a lower trading cost and a higher yield. Besides delivering attractive yields, many funds provide their investors with such services as check-writing privileges, custody (as a service), and bookkeeping. Investors also benefit from the knowledgeable investment choices of securities and investment objectives that funds offer.
The cost to the shareholder of investing in mutual funds comes in various forms: front-end loads, management fees, cost of maintaining and servicing shareholder accounts (administrative cost), redemption fees, and distribution fees (also known as 12b-1 fees). As mentioned before, a redemption fee is usually levied on shares held for less than a specified period. A distribution fee is a charge on current shareholders to cover the costs of advertising, promotion, selling, and other activities. It is sometimes combined with load charges. All these expenses are aggregated to obtain a single measure of cost to the shareholder. An aggregate measure commonly found in the published data is the expense ratio (expenses as a percent of assets). This measure does not include sales load, if there is one. Rea and Reid (1998) discuss the calculation of an alternative measure of total ownership cost that includes the sales load.
REGULATION AND TAXATION
All U.S. mutual funds are subject to strict regulation by the Securities and Exchange Commission. They are also subject to states's notice filing requirements and anti-fraud statutes. They are required to provide investors a full disclosure of their activities in a written prospectus. They also provide their investors a yearly statement of distribution with the details of the federal tax status of their distribution. Mutual funds in the United States are not subject to corporate income tax, if they meet certain Internal Revenue Code requirements. Instead, mutual fund shareholders are taxed on the distribution of fund's income. For tax purpose, mutual funds distribute their net income to the shareholders in two ways: (1) dividend and interest payments and (2) realized capital gains.
PERFORMANCE AND COMPARISON
The rate of return is widely used for comparing the performance of mutual funds. The rate of return on a mutual fund investment for a period of one year, for example, is calculated by adding the change in the NAV (NAVt–NAVt–1) to income and capital gains distributed during the year and dividing the sum by the NAV at the beginning of the year. The following describes the calculation of return for no-load funds:
where R, i, and c represent rate of return, income, and capital gains, respectively. For load funds, the calculation of return must account for load charges by adding them to the NAV. The performance of a mutual fund is often compared with the performance of a benchmark portfolio that is selected to reflect the investment risk level of the fund's portfolio to see whether the mutual fund had a superior performance.
The rate of return of a mutual fund with a NAV of $15.00 at the beginning of a year and $15.50 at the end of that year, and distributed $0.75 and $0.50 per share as income and capital gain respectively during the year would be:
[($15.50 − $15.00) + $0.75 + $0.50]/$15.00 = 11.67%
ANALYSIS AND REPORTING
Key statistics pertaining to a fund—such as the NAV, offer price, sales charges, expense ratio, and performance measure for various categories of funds—are regularly calculated, analyzed, and published. Two firms well known for their analytical service are the Lipper Analytical Services (Lipperweb.com) and the Morning Star Inc. (Morningstar.com). The Wall Street Journal and Barron's carry the information supplied by Lipper Analytical Services on a regular basis. Investment Company Institute (www.ici.org) also provides a wealth of information on mutual funds, including historical data and Web site addresses of its member funds.
see also Investments
Bogle, John (1994). Bogle on Mutual Funds. Burr Ridge, IL:Irwin.
Crane, Peter G. (1997). Mutual Fund Investing on the Internet. Burlington, MA: AP Professional.
Find the right mutual funds (2005). Hoboken, N.J.: Wiley.
Henriques, Diana B. (1995). Fidelity's World: The Secret Life and Public Power of the Mutual Fund Giant. New York: Scribner.
Investment Company Institute website. http://www.ici.org/index.html. Accessed December 1, 2005.
Lavine, Alan, and Liberman, Gail (2001). The Complete Idiot's Guide to Making Money with Mutual Funds. Indianapolis, IN: Alpha.
Levy, Haim (1999). Introduction to Investments. Cincinnati, OH: South-Western College Publishing.
Rea, John D., and Reid, Brian K. (1998, November). "Trends in the Ownership Cost of Equity Mutual Funds." ICI Perspective, 41(3), 2-15.
Sharpe, William F., Alexander, Gordon J., and Bailey, Jeffrey V. (1999). Investments. 6th ed., Upper Saddle River, NJ: Prentice Hall.
Anand G. Shetty
"Mutual Funds." Encyclopedia of Business and Finance, 2nd ed.. . Encyclopedia.com. (October 23, 2017). http://www.encyclopedia.com/finance/finance-and-accounting-magazines/mutual-funds
"Mutual Funds." Encyclopedia of Business and Finance, 2nd ed.. . Retrieved October 23, 2017 from Encyclopedia.com: http://www.encyclopedia.com/finance/finance-and-accounting-magazines/mutual-funds
A fund, in the form of an investment company, in which shareholders combine their money to invest in a variety of stocks, bonds, and money-market investments such as U.S. Treasury bills and bank certificates of deposit.
Mutual funds provide a form of investment that is both relatively safe and relatively lucrative. Mutual funds offer investors the advantages of professional management of invested money and diversification of that investment. Mutual fund managers assume the responsibility of investigating and researching financial markets and selecting the combination of stocks, bonds, and other investment vehicles to be bought and sold. Thus, consumers purchase shares in a mutual fund and rely on the expertise of the mutual fund manager, whose job is to provide them with the highest possible return on their investments.
Investing in a mutual fund is not as safe as investing in a bank or a savings and loan association. The federal government normally insures money deposited in banks or savings and loan associations; if one of those institutions fails, each of its deposits of up to $100,000 generally is guaranteed. This is not true of other investment vehicles such as stocks and bonds, which by their nature rise and fall in value and offer no guarantees. But investing in a mutual fund usually is considered to be safer than investing in individual stocks and bonds. Mutual fund managers observe the financial markets and take advantage of trends that affect the fund by buying and selling various components of the fund. And because a mutual fund is diverse—comprised perhaps of a hundred or more different kinds of stocks, bonds, or other investments—even the complete failure of one stock will make a relatively small impact on the fund's overall success.
There are two general types of mutual funds. An investor in an open-end fund may request at any time that the fund buy back, or redeem, that investor's shares. The price of shares in an open-end fund is based on the market value of the fund's portfolio of investments. Investors in open-end funds may be charged additional fees known as loads. Front-end loads are charged when the investor purchases shares in a mutual fund; back-end loads are subtracted from the redemption price. Open-end funds are sold by securities dealers and brokers and financial planners, or they are sold directly to the investor by the fund's sales staff.
Closed-end funds are traded on stock exchanges or the over-the-counter market. Unlike open-end funds, closed-end funds usually have a fixed number of shares, which are purchased and redeemed at their market price plus a commission.
Mutual funds are broadly classified according to three types of investment objectives: growth of capital, stability of capital, or current income. Most funds are geared toward one or two of these objectives. For example, money-market funds invest in instruments like U.S. Treasury bills, which are relatively safe and generally stable. Therefore many investors view money-market funds as a good alternative to a bank account. Other funds seek stability of capital by investing in blue-chip stocks and high-quality bonds. Some funds are potentially more lucrative, but far riskier. Growth funds are somewhat aggressive, investing in speculative securities that show promise over time for slow but steady long-term return. Income funds also tend to be speculative, often investing in high-risk, high-yield securities with the goal of greater short-term return.
Within the three broad categories of mutual funds are numerous subcategories. Funds that seek both growth and income are known as balanced funds. Sector funds invest in certain types of businesses, such as the computer industry. Some funds strive to fulfill a political agenda, such as investing in environmentally responsible companies or companies that actively promote women and minorities. Precious metals funds, municipal bond funds, and international stock funds are other examples of mutual fund categories. Other funds are far less specialized and allow the fund manager free reign to compile and alter the fund's portfolio.
Mutual fund shareholders receive periodic investment income, or dividends, which comes from dividends and interest earned by the various securities that make up the fund's portfolio. Shareholders often elect to have these dividends reinvested into the mutual fund. Investors in mutual funds may choose to make monthly payments into the fund or have a specified amount automatically withdrawn from a bank account or savings and loan association account each month. Some companies offer a variety of open-end mutual funds with different investment objectives and allow investors a simple way to switch their money from one fund to another as their savings goals change.
Securities laws, both state and federal, govern mutual funds. Some statutes regulate the organization of investment companies and the sale of securities by brokers and dealers. Federal securities laws that regulate mutual funds include the Securities Act of 1933 (15 U.S.C.A. § 77a et seq.), the Securities Exchange Act of 1934 (15 U.S.C.A. § 78a et seq.), and the Investment Company Act of 1940 (15 U.S.C.A. § 80a–1 et seq.).
Baer, Gregory, and Gary Gensler. 2002. The Great Mutual Fund Trap: An Investment Recovery Plan. New York: Broadway Books.
Blake, Erica. 2000."A Review and Analysis of the Monitoring of Personal Investment Transactions and the Implementation of Codes of Ethics." Annual Review of Banking Law 19 (annual): 637–53.
United States General Accounting Office. 2003. Mutual Funds: Greater Transparency Needed in Disclosures toInvestors: Report to Congressional Requesters. Washington, D.C.: General Accounting Office.
"Mutual Fund." West's Encyclopedia of American Law. . Encyclopedia.com. (October 23, 2017). http://www.encyclopedia.com/law/encyclopedias-almanacs-transcripts-and-maps/mutual-fund
"Mutual Fund." West's Encyclopedia of American Law. . Retrieved October 23, 2017 from Encyclopedia.com: http://www.encyclopedia.com/law/encyclopedias-almanacs-transcripts-and-maps/mutual-fund
mutual fund, in finance, investment company or trust that has a very fluid capital stock. It is unique in that at any time it can sell or redeem any of its outstanding shares at net asset value (i.e., the price of a share equals total assets minus liabilities divided by the total number of shares). A mutual fund, also called an open-end investment company, owns the securities of several corporations and receives dividends on the shares that it holds. A closed-end investment company differs from an open-end company in that the number of shares is limited and the price of the shares may fluctuate above and below the net asset value. The earnings of a mutual fund are distributed to the holders of its shares. It is hoped that a loss on one holding will be made up by a gain on another. The holders of mutual-fund shares thus gain the advantage of diversification, which might ordinarily be beyond their means. Common mutual funds, which often provide skilled management for security holdings, include stock, bond, balanced, index, and money-market funds. Stock funds mainly invest in common shares, and bond funds in bonds; such funds may specialize in a particular category of stocks or bonds (such as Internet stocks or municipal bonds). A balanced fund might invest in preferred stocks and bonds in addition to common stocks. Index funds invest in a portfolio that mimics a given index, such as the stocks that make up the S&P 500. The forerunner of the modern mutual fund was established in Belgium in 1822, and the use of these closed-end investment companies soon spread to Great Britain and France. They became popular in the United States in the 1920s, but from the 1930s the open-end mutual fund became more popular. Mutual funds experienced a period of tremendous growth after World War II, especially in the 1980s and 90s.
See M. Useem, Investor Capitalism: How Money Managers Are Changing the Face of Corporate America (1996).
"mutual fund." The Columbia Encyclopedia, 6th ed.. . Encyclopedia.com. (October 23, 2017). http://www.encyclopedia.com/reference/encyclopedias-almanacs-transcripts-and-maps/mutual-fund
"mutual fund." The Columbia Encyclopedia, 6th ed.. . Retrieved October 23, 2017 from Encyclopedia.com: http://www.encyclopedia.com/reference/encyclopedias-almanacs-transcripts-and-maps/mutual-fund
A mutual fund is a large, diverse group of stocks and/or bonds in which an individual may invest. There are three basic types of mutual funds. Money market funds invest in certificates of deposit, U.S. Treasury bills, and other low-risk, short-term securities that provide a safe, low-return alternative to checking accounts. The medium-risk bond and income funds invest in both stocks and corporate and government debt, with the goal of invest exclusively in the stock of corporations. The higher risk equity fund invests in the stocks of corporations and comes in all shapes and sizes. Mutual funds are also classified as "closed-end" (a fixed number of shares are sold to the public) and "open-end" (shares are sold to as many people as want them).
Low, medium, and high risk mutual funds each have many options for investment. One class of higher-risk funds is the aggressive growth equity fund, which may be suitable for an individual looking for a quick return on an investment. A less risky kind of mutual fund, the index equity fund, takes the process of picking stocks out of the hands of mutual fund managers and instead invests in companies listed in such stock market indices as the Standard and Poor's 500. Sector equity funds specialize in specific segments of the economy, such as telecommunications, biotechnology, or Internet stocks. While many opportunities exist for domestic investment, an individual can also look to the foreign markets as a place to invest money. International equity funds focus on the stocks of non-U.S. companies and may be region specific, such as an Asia or Latin America fund.
Mutual funds first appeared in Europe in the nineteenth century and were well established in the United States by 1900. Not until 1924, however, did the first modern open-end mutual fund appear—it boasted forty-five stocks and $50,000 in assets. The stock market crash of 1929 soured an entire generation on stock investing, however, and it took new government safeguards and the post-World War II (1939–1945) economic boom to convince U.S. citizens to return to stock investing. In the 1940s there were only about 80 mutual funds with assets of $500 million. In 1948 one of the first sector funds, Television Funds, Inc., was launched; it was followed in 1953 by the first international mutual fund. The number of funds edged up to 100 in the 1950s, but by 1952 still only onequarter of one percent of the U.S. population owned stocks. The first aggressive growth mutual fund appeared in the 1960s, and in the 1970s money market funds and bond and income funds became more common. Fueled by the beginning of one of the longest bull markets in U.S. history in 1982, the number of funds grew fivefold in the 1980s. By the late 1990s, the nation's 6,700 mutual funds owned 22 percent of the entire U.S. stock market and held assets of more than $4.5 trillion.
See also: Bond, Investment, Standard and Poor's, Stock, Stock Market
"Mutual Fund." Gale Encyclopedia of U.S. Economic History. . Encyclopedia.com. (October 23, 2017). http://www.encyclopedia.com/history/encyclopedias-almanacs-transcripts-and-maps/mutual-fund
"Mutual Fund." Gale Encyclopedia of U.S. Economic History. . Retrieved October 23, 2017 from Encyclopedia.com: http://www.encyclopedia.com/history/encyclopedias-almanacs-transcripts-and-maps/mutual-fund
mu·tu·al fund • n. an investment program funded by shareholders that trades in diversified holdings and is professionally managed.
"mutual fund." The Oxford Pocket Dictionary of Current English. . Encyclopedia.com. (October 23, 2017). http://www.encyclopedia.com/humanities/dictionaries-thesauruses-pictures-and-press-releases/mutual-fund
"mutual fund." The Oxford Pocket Dictionary of Current English. . Retrieved October 23, 2017 from Encyclopedia.com: http://www.encyclopedia.com/humanities/dictionaries-thesauruses-pictures-and-press-releases/mutual-fund