A mutual fund (aka managed fund)
enables investors to pool their money and place it under
professional investment management. The portfolio manager
trades the fund's underlying securities, realizing a gain or
loss, and collects the dividend or interest income. The
investment proceeds are then passed along to the individual
investors. There are more mutual funds than there are
individual stocks.
Net asset value: The net asset value,
or NAV, is a fund's value of its holdings, usually expressed as
a per-share amount. For most funds, the NAV is determined
daily, after the close of trading on some specified financial
exchange, but some funds update their NAV multiple times during
the trading day. Open-end funds sell and redeem their shares at
the NAV, and so only process orders after the NAV is
determined. Closed-end funds may trade at a higher or lower
price than their NAV; this is known as a premium or discount,
respectively. If a fund is divided into multiple classes of
shares, each class will typically have its own NAV, reflecting
differences in fees and expenses paid by the different
classes.
Some mutual funds own securities which are
not regularly traded on any formal exchange. These may be
shares in very small or bankrupt companies; they may be
derivatives; or they may be private investments in unregistered
financial instruments (such as stock in a non-public company).
In the absence of a public market for these securities, it is
the responsibility of the fund manager to form an estimate of
their value when computing the NAV. How much of a fund's assets
may be invested in such securities is stated in the fund's
prospectus.
Open-end
fund: In an
open-end fund, the units of a mutual fund are bought and
sold by the fund company. The price at which an investor
buys the fund is usually higher than the price at which he
sells the fund to the fund company.
Closed-end
fund: Unlike the
buying and selling of funds conducted by the fund company in
an open-end fund, the units of close-end funds are traded on
a stock exchange.
Dividend
option: The fund
earns income from the profit it makes from investing in
securities as well as from earning dividends on those
securities. Fund companies offer investors the option of
earning some of the earnings by way of dividends and
reducing the NAV (Net Asset Value) of the fund
proportionally by the dividend amount.
Growth
option: The fund
earns income from the profit it makes from investing in
securities as well as from earning dividends on those
securities. In growth option, the investor leaves the earned
profits in the mutual fund, which gets invested in earning
more returns.
Equity
Fund: An equity
fund invests most of its assets in stocks/shares of listed
companies. The fund earns returns from investing in stocks
in the form of capital gains (the difference between buying
and selling stocks) as well as dividends earned from these
investments. Risk attached to an equity fund is the
highest amongst all mutual funds.
Debt
Fund/Income Fund/Bond Fund:
Such a fund invests in interest bearing
securities mainly government securities and corporate bonds.
This fund earns returns for its investors from interest
income on its investments and profits on trading securities.
In terms of risk, this type of fund is the least
risky. There is also another category of
fund called "Liquid
Funds" which servers the need
of very short term investing.
Load: A front-end load or sales
charge is a commission paid to a broker by a mutual fund when
shares are purchased, taken as a percentage of funds invested.
The value of the investment is reduced by the amount of the
load. Some funds have a deferred sales charge or back-end load
which is paid to the broker out of the proceeds when shares are
redeemed. (This is distinct from a redemption fee, which is
also paid out of proceeds, but is kept by the fund. Many funds
charge redemption fees when shares are sold a short time after
they are purchased, to discourage investors from market
timing.) Load funds are sold through financial intermediaries
such as brokers, financial planners, and other types of
registered representatives who charge a commission for their
services.
It is possible to buy many mutual funds
directly from the fund sponsor, without paying a sales charge.
These are called no-load funds. Some discount brokers will sell
no-load funds, sometimes for a flat transaction fee or even no
fee at all. (This does not necessarily mean that the broker is
not compensated for the transaction; in such cases, the fund
may pay brokers' commissions out of "distribution and
marketing" expenses rather than a specific sales charge.)
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