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What Is a Mutual Fund?

by Guest on February 2, 2011

Mutual Funds are no longer an arcane investment tool, but have gained enormous popularity over the past several decades.

As the common investment vehicle used in most employer 401K benefit plans, mutual funds are the investment vehicle of choice by over 80 million Americans, constituting over 50% of available households.

Although the origin of mutual funds can be traced back to the eighteenth century, the modern day version of the fund was given birth in Boston in 1924. From that point on, the concept has grown in acceptability to the point that trillions of dollars are invested in over 10,000 separate offerings managed by both large and boutique fund managers.

The definition of a mutual fund, provided by a trusted Internet authority, is

“An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets.”

For beginning investors, these funds represent an excellent tool for learning the basic principles of investing, including diversification, sector focused investing, and delegated management and related cost structures. They also enable an investor with minimal capital to invest in a variety of opportunities that otherwise would be precluded due to financial constraints.

Fund managers have not ignored product development either. Mutual funds now come in a variety of types to meet every investor’s objectives, from industry specialization and various stock indexes to special situations and emerging market funds.

An investor can pick and choose at will, with minimal restrictions on redemptions, and construct a portfolio that matches his personal perspective on the market. Each fund, on the other hand, manages its portfolio based on the specific objectives detailed in the fund’s prospectus.

Fund manager compensation also varies, depending on the type of fund, its stated tolerance for risk, and the sales structure associated with the distribution of fund units. These costs are important since they reduce whatever return you may earn over time.

As with any other well-developed industry, fund purveyors have learned to disguise their actual fees with complex disclosures and layers of financial information. Care should be taken to understand any fees that apply to operating the fund on a daily basis, as opposed to “loads” that are often collected when units are either bought or sold.

For the past five years, many investors have sought diversification and return in global investment funds that focus on specific regions or developing countries.   Oftentimes, another country’s economy is growing more quickly than your own. You do not need to take a forex course to sort through the complex currency exchange fluctuations. Fund managers employ their own fx brokers to handle exchanges, and units in the funds remain in U.S. Dollars.

One restriction, however, that mutual funds possess is that values are determined on an “end-of-day” basis. All accounting and fee charges are performed daily, and a single unit value is then used for all purchases and redemptions.

Some funds may also delay or restrict redemptions if the assets or securities have low liquidity in the market, as with real estate or micro-cap companies. For this reason alone, exchange-traded funds, or ETFs, have gained in popularity since they offer the flexibility of trading on exchanges like shares are traded for any stock today.

Mutual funds have had a stellar history and benefited many investors. However, as one commentator recently stated, “the growing use of ETFs means the future of mutual funds will be anything but smooth.”

This has been a guest post by Jason Hoerr of Forex Traders.

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