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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


funds.


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


help.


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


blow.


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


investing.


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


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