A mutual fund is a type of professionally managed investment
fund that pools money from many investors to purchase securities.[1] While
there is no legal definition of the term "mutual fund", it is most
commonly applied only to those collective investment vehicles that are
regulated and sold to the general public. They are sometimes referred to as
"investment companies" or "registered investment companies".
Hedge funds are not mutual funds, primarily because they cannot be sold to the
general public.
In the United States, mutual funds must be registered with
the U.S. Securities and Exchange Commission, overseen by a board of directors
or board of trustees, and managed by a Registered Investment Advisor. Mutual
funds are also subject to an extensive and detailed regulatory regime set forth
in the Investment Company Act of 1940. Mutual funds are not taxed on their
income and profits if they comply with certain requirements under the U.S.
Internal Revenue Code.
Mutual funds have both advantages and disadvantages compared
to direct investing in individual securities. Today they play an important role
in household finances, most notably in retirement planning.
There are three types of U.S. mutual funds—open-end funds,
unit investment trusts, and closed-end funds. The most common type, open-end
funds, must be willing to buy back shares from investors every business day.
Exchange-traded funds (ETFs) are open-end funds or unit investment trusts that
trade on an exchange. Non-exchange traded open-end funds are most common, but
ETFs have been gaining in popularity.
Mutual funds are generally classified by their principal
investments. The four main categories of funds are money market funds, bond or
fixed income funds, stock or equity funds, and hybrid funds. Funds may also be
categorized as index (or passively managed) or actively managed.
Advantages and disadvantages
Mutual funds have advantages over investing directly in
individual securities:
Increased diversification: A fund normally holds many
securities; diversification decreases risk.
Daily liquidity: Shareholders of open-end funds and unit
investment trusts may sell their holdings back to the fund at the close of
every trading day at a price equal to the closing net asset value of the fund's
holdings.
Professional investment management: Open-and closed-end
funds hire portfolio managers to supervise the fund's investments.
Ability to participate in investments that may be available
only to larger investors. For example, individual investors often find it
difficult to invest directly in foreign markets.
Service and convenience: Funds often provide services such
as check writing.
Government oversight: Mutual funds are regulated by the SEC
Ease of comparison: All mutual funds are required to report
the same information to investors, which makes them easy to compare.
Low Investment Threshold: Since the portfolio is diversified
with a no-load fund, investors may have to pay little or no sales charges to
own mutual funds[4]
Mutual funds have disadvantages as well, which include:
Fees
Less control over timing of recognition of gains
Less predictable income
No opportunity to customize
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