48. What is a Mutual Fund?


Generally speaking, a mutual fund is an investment company that provides a means for many people to pool their money in order to attain greater diversification of their investments.

A mutual fund invests in many different companies and in many different securities, getting the funds with which to make these investments from three main sources:

(1) Through the sale of its own shares to the public;

(2) Through its own reinvestment of some of the proceeds from the sale of portfolio securities; and

(3) Through the reinvestment by shareholders of their investment income dividends and capital gain distributions (the net gains, ifany, derived by the fund over the year on sales of portfolio
securities).

A mutual fund is an investment company. However, a mutual fund is a particular breed of investment company known as an open-end investment company. The other major type of investment company is known as a closed end investment company.

A closed-end investment company, like most regular corporations and unlike a mutual fund, has a fixed number of shares outstanding. It may have senior securities (preferred stock and bonds) as well as common stock. The common shares of a closed-end company have been issued sometime in the past, and they are now bought and sold just like any other publicly traded securities--through brokers and dealers. Some closed-end companies are traded on the New York or American Stock Exchanges; others, over the counter. Accordingly, their prices are determined both by their underlying asset values and by the usual workings of supply and demand in the market for the limited number of shares available.

On the other hand, open-end mutual funds do not have fixed capitalization and issue only common stock. They are continuously offering new shares to the public and buying them back on demand.

The buying and selling of mutual funds is very different from the buying and selling of closed-end investment company stock or common stock. Funds are not listed on any exchange and are not traded in the over-the-counter market in the normal sense. Most mutual funds are sold through persons who are independent brokers and dealers or members of the fund's own sales force. No-load funds are sold through the mail without any sales force. But in any case, the purchaser is buying the shares from the fund, not from another shareholder.

Just as different individuals have different financial objectives, different mutual funds have different financial objectives. For instance, some seek growth without too much attention to income, some seek income and aren't too concerned about growth, while others try to strike a balance between income and growth. Needless to say, when you invest in a mutual fund as part of your financial plan, you will have to match a fund's financial objectives to those of your own. Thus, it becomes vital for you to have a good working knowledge of different types of funds.

GROWTH FUNDS - The mutual funds that have probably attracted more investor interest than other types and have contributed very largely to the growth of the mutual-fund industry are the so-called "growth" funds. Their
emphasis is on long-term growth of invested capital with only secondary or no attention being paid to current income return.

AGGRESSIVE GROWTH FUNDS: Members of this subgroup of mutual funds, sometimes called "go-go funds," are not clearly determined. Most of the popularized writings on the subject simply pick the best-performing funds among the smaller growth funds and label them "aggressive". However, some are truly so and will make this clear in their prospectuses. They may say, for example, that the shares are for sophisticated investors seeking long-term growth of capital who are prepared to accept greater than normal risk and greater than average interim fluctuations in underlying asset value.

GROWTH-INCOME FUNDS - Many investors want to share in capital appreciation but are unwilling to forgo a dividend return on their investments. For this type of individual, usually a person either close to
retirement or one who does not need the relative stability provided by the fixed-income securities of a balanced fund, the growth-income fund is ideal. It manages to return a reasonable amount of income from dividends received on portfolio securities, while still investing in enough growth- oriented issues to allow for potential capital appreciation.

INCOME FUNDS - The typical income fund, unlike the typical growth income fund, is not interested at all in potential capital appreciation but wants to pay the highest possible current dividends to its shareholders
commensurate with the risks it feels it should take.

COMMON-STOCK FUNDS - A so-called common-stock fund may be either a growth, growth-income, or income fund. Its name merely denotes the fact that it seeks to reach its investment goal by the technique of remaining almost 100% invested in common stocks. The common-stock fund, in its broad generic sense, represents the most prevalent type of mutual fund. About 75% of the assets of all mutual funds are held by common-stock funds. They usually do not restrict their ability to take defensive positions in a declining market by holding cash or buying senior security issues, but return to near 100% common stock when that seems prudent.

BALANCED FUNDS - Generally regarded as the most conservative of the mutual funds by both the industry and investors alike, a "balanced fund" at all times maintains a balance between the common stocks in its portfolio (anywhere from around 50% to 75% usually) and senior securities such as preferred stock, bonds, and U.S. government obligations.

MUNICIPAL-BOND FUNDS - These funds invest in bonds issued by states, cities, and other local governments. They offer all of the conveniences of other mutual funds and the interest earned on bonds invested in by a fund is passed on to the investors free of federal tax.

MONEY-MARKET FUNDS - Also referred to as reserve funds, cash funds or liquid assets, these mutual funds invest in short-term, relatively high yield securities, such as U.S. government securities and bank certificates
of deposit. There is no cost to make deposits to or withdraw amounts from the money funds, although there is a small management fee. There are check writing privileges (usually in amounts of $500 or more), and an investor can withdraw dollar for dollar what he or she has put into the fund, including dividends, which are automatically credited to the investor's account as additional shares.

Interest paid from money-market funds can vary on a daily basis and usually reflects interest rates paid on CDs and Treasury bills. This higher yield offers stiff competition to bank checking accounts that pay the legal maximum of 5-1/4%

The amount of risk involved varies only slightly from fund to fund even though the funds invest in a variety of securities. Money-market funds are considered relatively safe investments, though investors are warned that deposits in these funds are not covered by the federal government's insurance against losses of up to $100,000.

SPECIALTY FUNDS - Specialty funds concentrate on investments in special types of securities, in regional investments, or in investments in certain industries. For example, many doctors have preferences for mutual funds that invest heavily in pharmaceutical companies and other companies related to the medical industry. The insurance and banking industries have also generated enough investor enthusiasm to have spawned their own industry funds, sometimes combining insurance with the banking field. There are funds that invest solely in public utilities and funds that seek investment opportunities only in emerging industries. Another group of specialty funds invests in international issues. Another type, the geographical-area fund, makes investments that are tied into the growth of a particular area of the country.

"GINNIE MAE" FUNDS - A "Ginnie Mae" is a mortgage-backed security guaranteed by the Government National Mortgage Association. One of the attractions of a Ginnie Mae is that it pays a fixed return that is often higher than that of a long-term bond.

Tax reference verification 1-800-829-1040

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