A mutual
fund is a type of professionally managed collective
investment scheme that pools money from many investors to purchase
securities. 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." Most mutual funds are
"open-ended," meaning stockholders can buy or sell shares of the
fund at any time. Hedge funds are not considered a type of mutual
fund.
Mutual funds have advantages
compared to direct investing in individual securities.
These include:
- Increased diversification: A fund
must hold many securities. Diversifying reduces risks compared to
holding a single stock, bond, other available
instruments.
- Daily liquidity: This concept
applies only to open-end funds. Shareholders may trade their
holdings with the fund manager at the close of a trading day based
on the closing net asset value of the fund's holdings. However,
there may be fees and restrictions as stated in the fund
prospectus. For holders of individual stocks, bonds, closed-end
funds, ETFs, and other available instruments, there may not be a
buyer/seller for that instrument everyday. Such instruments are
termed, illiquid.
- Professional investment
management: A highly variable aspect of a fund discussed in the
prospectus. Actively managed funds funds may have large staffs of
analysts who actively trade the fund holdings. Management of an
index fund may just passively re-balance holdings to match a market
index like the Standard and Poors 500 Index.
- Ability to participate in
investments that may be available only to larger investors: Foreign
markets, in particular, are rarely open and affordable for
individual investors. More over the research required to make
sensible foreign investments may require knowledge of another
language, and the rules of regulations of other
markets.
- Service and convenience: This is
not a feature of a mutual fund, but rather a feature of the fund
management company. Increasingly in recent years, there are funds,
notably Exchange Traded Funds(ETFs) that are purely investment
instruments without any additional services from the fund
management company.
- Government oversight: Largely,
the US government's role with mutual funds is to require the
publication of a prospectus describing the fund. No such document
is required for stock, bonds, currencies, and other investment
instruments. There is no governmental oversight of a fund's
investment success/failure.
- Ease of comparison: Since mutual
funds are available from many providers, it is generally easy to
find similar funds and compare features such as
expenses.
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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