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What Are Mutual Funds Essay Research Paper

What Are Mutual Funds? Essay, Research Paper

What is a Mutual Fund and How Does It Work?

Think of a mutual fund as an investment company that pools the money

of people just like you for one common reason — to make more. Not all

pots of money, though, are alike. Each mutual fund has its own strategy

and investment objective for making money. It’s up to you to select the

right mutual fund for you based on your own needs.

There are two types of mutual funds. The most common, which this

book primarily talks about, is open-end funds. In essence, they are open

– money flows directly into the fund when investors buy and goes

directly out when they sell. The other type is closed-end funds, which

technically are not mutual funds. You’ll learn more about them in

Chapter 16.

With a mutual fund, the big pool of money we talked about previously is

managed by a company, which frequently the organization that started

the fund. This management company either serves as or hires the

fund’s investment advisor. The advisor employs a portfolio manager and

his or her research staff to select the investments for the mutual fund.

Mutual funds are subject to strict federal regulations. The fund broker or

other salesperson is required to give you a prospectus before you

invest. The prospectus is an important document that spells out the

investment objectives of the fund, risks, fees, and other important

information. You’ll learn more about what’s in a prospectus and what you

should look for in Chapter 9. The Securities and Exchange Commission

(SEC) is the U.S. government agency in charge of regulating mutual


Generally, mutual funds continuously offer new shares to the public.

They also are required legally to buy back outstanding shares at the

shareholder’s request. When you sell shares in a fund, you receive a

check based on its share’s price or net asset value (less any sales

charges, if applicable). The net asset value is obtained when the fund

figures the value of its investments, less liabilities, divided by the number

of shares outstanding at the end of the day.

Technobabble: The investment advisor is an organization hired by the

mutual fund company to manage a mutual fund’s investments. A

portfolio manager is the professional who actually manages the fund.

The investment objective describes what your mutual fund hopes to

accomplish. Assets represent any investment that the mutual fund

holds, including stocks, bonds, and cash reserves. A mutual fund share

is a unit of ownership in the fund. A mutual fund investor who owns

shares is called a shareholder and has voting rights.

Introducing: The Cast of a Mutual Fund

Like any company, the mutual fund management company is an

organization with a number of people that run the show. You want to

understand how this company works because you’ve entrusted it with

your hard-earned cash. Although mutual funds are set up under state

law, usually as corporations, they differ from other companies.

First, they are legally entitled to hire companies to handle the bulk of their

services. They typically hire the investment advisor, also known as an

investment advisory firm, to manage your mutual fund. They also make

arrangements to have the fund sold through a brokerage firm.

The following sections review the cast of characters who make a mutual

fund work.

The Investment Advisor

The investment advisor is one — or in some cases, a group — of the key

people in a mutual fund, including the portfolio manager(s) and

his/her/their staff. You’ve probably seen some portfolio managers on

TV’s “Wall Street Week,” spotted their quotes in magazines, or read

some of their books. This person selects, buys, and sells the

investments based on the fund’s investment objectives. The investment

advisor is paid an annual fee based on a percentage of the value of the

fund’s cash and investments, or assets.

The Board of Directors

A mutual fund has a board of directors to make major policy decisions

and oversee management. These are important people. The directors

steer the fund’s course, determining investment objectives and hiring out


The Shareholder

Mutual fund investors are also known as shareholders. When you invest

in a mutual fund, you actually buy a share or portion of a mutual fund.

Each share has a price tag. If a fund sells for $10 a share and you invest

$1,000, you’re the proud owner of 100 shares of the fund! Mutual funds,

like many other companies, are very democratic. Because you own

shares in the fund, you have voting rights. As part owner, a shareholder

gets to vote in the election of the board of directors. The shareholder

must approve many operational changes within the fund, including

accounting procedures and the investment objective.

Custodians and Transfer Agents

As you can imagine, the millions of mutual fund transactions executed

each year require a gargantuan behind-the-scenes record-keeping

effort. The securities a mutual fund invests in are kept under lock and

key by an appointed custodian, usually a bank. The custodian may

respond only to instructions from fund officers responsible for dealing

with the custodian. The custodian safeguards the fund’s assets, makes

payments for the fund’s securities, and receives payments when

securities are sold.

Fund transfer agents maintain shareholder account records, including

purchases, sales, and account balances. They also authorize the

payments made by the custodian (referred to previously), prepare and

mail account statements, maintain a customer service department to

respond to account inquiries, and provide federal income tax

information, shareholder notices, and confirmation statements.

The Underwriter

The underwriter is an organization with a staff of salespeople who either

administers sales directly to the public or meets with the brokerage

firms to convince them to sell the fund. Brokers sell fund shares to the

public and collect a commission for the sale. Chapter 8 goes into more

detail about what you pay for a mutual fund and who sells them.

Mutual Funds Make It EZ to Invest

Boy, there are a lot of important people and ingredients that go into the

making of a mutual fund. The end result, however, is that mutual funds

provide one of the simplest ways to invest — especially if you count

yourself among us working stiffs, and lack time and training to manage

money like the Wall Street big boys.

The major difference between investing in a mutual fund and investing in

an individual stock or bond is that with a mutual fund, instead of buying

just one stock or bond, you really buy a portion of a variety of

investments. Exactly how much money you make or lose in a mutual

fund can change daily, as you’ll learn in later chapters. It all depends on

how many shares you own and how well your mix of investments

perform. As Chapter 3 explains, owning a lot of different investments

helps to protect you against losing money. If one investment in your

mutual fund does poorly, you have a number of others to cushion the


Sidelines: There are approximately 6,000 mutual funds, but not all are

alike. Depending on your particular needs, you can find a mutual fund

that’s right for you. In Chapters 3 and 5, you’ll learn more about the

different types of mutual funds.

The 10 Commandments Of Mutual Fund Investing

Have we whetted your appetite? Good. Let’s get ready to proceed.

However, we don’t want you to invest one penny in a mutual fund until

you read and thoroughly digest these 10 critical rules of mutual fund


1.Always understand what you are investing in. You can lose a

bundle if you pick the wrong kind of mutual fund. Read carefully the

free literature that mutual fund companies provide on their funds.

2.Don’t rush out and buy the first mutual fund that looks good.

You first have to identify your investment goals, determine how

much you need from your investment (see Chapter 2), and figure

out how much you’re willing to risk losing (see Chapter 6).

3.Don’t try to make quick profits. Always invest for the long term.

You should plan to keep some of your mutual funds an absolute

minimum of 5 to 10 years.

4.Mix up your investments. You can cut your chances of losing

money by putting your money in different types of investments.

Chapter 6 shows you how.

5.Invest regularly with each paycheck — before you have a

chance to spend all your money. Mutual funds have automatic

investment programs. Money is electronically taken out of your

checking account and invested in the fund.

6.Do your homework. Once you determined how much money you

need and by when — as well as how much you can afford to lose

– research the best investments to meet your goals. Most library

business sections carry information on mutual funds.

7.Avoid paying high commissions and fees for mutual funds.

Make your money work for you, not for your stock broker. Read

about this in Chapter 7.

8.Make sure your mutual fund investment earns enough so

that your nest egg at least keeps pace with rising prices.

Chapter 5 discusses this further.

9.Know when to sell your mutual funds. Chapter 16 explains

ways to evaluate how a fund is doing. You’ll learn when to get rid

of a mutual fund that’s a lemon.

10.Invest to beat the tax man. Take advantage of an Individual

Retirement Accounts (IRAs) and other tax shelters. Chapter 22

discusses how you can make tax-deductible contributions and

watch your money grow tax-free until you retire