Understanding Mutual Fund

What is a Mutual Fund?

A mutual fund is a professionally managed collective investment strategy that pools money from multiple investors for the mass-purchase of investment securities. Mutual funds--which are typically comprised of stocks, short-term money market instruments, bonds, commodities, other mutual funds, and other securities—are popular investment options due to their enhanced strategy and their ability to diversify risk through wide-spread investment of multiple industries and sectors.

A mutual fund is managed and run by a fund manager that trades (actively buys and sells) the fund’s investments in accordance to the fund’s overall investment strategy or objective.

Who Manages Mutual Funds?

In the United States, all mutual funds are registered with the Securities and Exchange Commission (SEC) under both the Internal Revenue Service (IRS) and SEC’s regulations. As a result of this adherence, all mutual funds that are formally created in the United States must distribute nearly all of its net realized gains and net income from the sale of their securities to its investors. The distribution of gains and income must be awarded to those individuals who invest in the fund (who deliver funds to the manager for the right to buy and sell securities) at least annually.

The majority of funds in the United States are overseen by a group of managers or by a board of directors. As a result of this structure, the board, along with the investment adviser and other service organizations, is primarily responsible for ensuring that the fund is managed appropriately and in accordance with the bylaws of the fund’s investment objective. Regardless of the fund’s organizational structure; however, all mutual funds must manage their investments based on the best interest of the fund’s investors.

Types of Mutual Investment Companies

Since the passage of the Investment Company Act of 1940 and the Investment Advisers Act of 1940, there have been three general types of registered investment companies in the United States of America: open-end funds (mutual funds), closed-end funds and unit investment trusts. Recently; however, this classical interpretation of an investment company has evolved to include novel types of investment strategies, such as exchange-traded funds and hedge funds.
Open-ended Funds

The term “open-ended fund” simply means that at the end of every trading day, the mutual fund will continually issue new shares to potential investors who will buy into the fund and must be ready to buy back shares from investors redeeming their shares at the present net asset value per share.

Mutual funds are structured as corporations or trusts, such as business trusts. Any corporation will be classified by the Securities and Exchange Commission as an investment company if the fund issues securities and predominantly invests in non-government securities. An investment fund will be classified as an open-investment company by the SEC if the fund does not issue undivided interests in specific securities and if it issues redeemable securities.

Average Annual Return of a Mutual Fund

Mutual funds in the United States must use SEC form N-1A to report their average annual compounded rates of return for 1-year, 5-year and 10-year timeframes; the average annual compounded rates elucidate upon the average annual total return of the fund.

The following formula is used to calculate the average annual total return of a mutual fund: P (1+T)^n=ERV where P=a hypothetical initial payment; T=the average annual total return; and N=total number of years.

Fees Associated with a Mutual Fund

The fee structure associated with a mutual fund is divided into two or three components: non-management expenses, management fees, and the fees associated with 12b-1/non-12b-1 fees. All expenses associated with a mutual fund are expressed as a percentage of the average net assets of the fund.

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