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A fund, in the form of an investment company, in which shareholders combine their money to invest in a variety of stocks, bonds, and money-market investments such as U.S. Treasury bills and bank certificates of deposit.
Mutual funds provide a form of investment that is both relatively safe and relatively lucrative. Mutual funds offer investors the advantages of professional management of invested money and diversification of that investment. Mutual fund managers assume the responsibility of investigating and researching financial markets and selecting the combination of stocks, bonds, and other investment vehicles to be bought and sold. Thus, consumers purchase shares in a mutual fund and rely on the expertise of the mutual fund manager, whose job is to provide them with the highest possible return on their investments.Investing in a mutual fund is not as safe as investing in a bank or a Savings and Loan Association. The federal government normally insures money deposited in banks or savings and loan associations; if one of those institutions fails, each of its deposits of up to $100,000 generally is guaranteed. This is not true of other investment vehicles such as stocks and bonds, which by their nature rise and fall in value and offer no guarantees. But investing in a mutual fund usually is considered to be safer than investing in individual stocks and bonds. Mutual fund managers observe the financial markets and take advantage of trends that affect the fund by buying and selling various components of the fund. And because a mutual fund is diverse—comprised perhaps of a hundred or more different kinds of stocks, bonds, or other investments—even the complete failure of one stock will make a relatively small impact on the fund's overall success.
There are two general types of mutual funds. An investor in an open-end fund may request at any time that the fund buy back, or redeem, that investor's shares. The price of shares in an open-end fund is based on the market value of the fund's portfolio of investments. Investors in open-end funds may be charged additional fees known as loads. Front-end loads are charged when the investor purchases shares in a mutual fund; back-end loads are subtracted from the redemption price. Open-end funds are sold by Securities dealers and brokers and financial planners, or they are sold directly to the investor by the fund's sales staff.
Closed-end funds are traded on stock exchanges or the over-the-counter market. Unlike open-end funds, closed-end funds usually have a fixed number of shares, which are purchased and redeemed at their market price plus a commission.
Mutual funds are broadly classified according to three types of investment objectives: growth of capital, stability of capital, or current income. Most funds are geared toward one or two of these objectives. For example, money-market funds invest in instruments like U.S. Treasury bills, which are relatively safe and generally stable. Therefore many investors view money-market funds as a good alternative to a bank account. Other funds seek stability of capital by investing in blue-chip stocks and high-quality bonds. Some funds are potentially more lucrative, but far riskier. Growth funds are somewhat aggressive, investing in speculative securities that show promise over time for slow but steady long-term return. Income funds also tend to be speculative, often investing in high-risk, high-yield securities with the goal of greater short-term return.
Within the three broad categories of mutual funds are numerous subcategories. Funds that seek both growth and income are known as balanced funds. Sector funds invest in certain types of businesses, such as the computer industry. Some funds strive to fulfill a political agenda, such as investing in environmentally responsible companies or companies that actively promote women and minorities. Precious metals funds, municipal bond funds, and international stock funds are other examples of mutual fund categories. Other funds are far less specialized and allow the fund manager free reign to compile and alter the fund's portfolio.
Mutual fund shareholders receive periodic investment income, or dividends, which comes from dividends and interest earned by the various securities that make up the fund's portfolio. Shareholders often elect to have these dividends reinvested into the mutual fund. Investors in mutual funds may choose to make monthly payments into the fund or have a specified amount automatically withdrawn from a bank account or savings and loan association account each month. Some companies offer a variety of open-end mutual funds with different investment objectives and allow investors a simple way to switch their money from one fund to another as their savings goals change.
Securities laws, both state and federal, govern mutual funds. Some statutes regulate the organization of investment companies and the sale of securities by brokers and dealers. Federal securities laws that regulate mutual funds include the Securities Act of 1933 (15 U.S.C.A. § 77a et seq.), the Securities Exchange Act of 1934 (15 U.S.C.A. § 78a et seq.), and the Investment Company Act of 1940 (15 U.S.C.A. § 80a–1 et seq.).
Baer, Gregory, and Gary Gensler. 2002. The Great Mutual Fund Trap: An Investment Recovery Plan. New York: Broadway Books.
Blake, Erica. 2000."A Review and Analysis of the Monitoring of Personal Investment Transactions and the Implementation of Codes of Ethics." Annual Review of Banking Law 19 (annual): 637–53.
United States General Accounting Office. 2003. Mutual Funds: Greater Transparency Needed in Disclosures to Investors: Report to Congressional Requesters. Washington, D.C.: General Accounting Office.