Investment funds allow both small and big investors to pool their money together, potentially earning higher returns with less risk compared to private brokerage accounts. Mutual funds come with numerous advantages such as easy diversification, professional management, lower trading fees, and increased liquidity. However, to invest wisely in these funds, it’s essential to do your homework. The type of fund you choose should match your financial goals—whether you’re aiming for capital growth or income—and your investment philosophy. This includes factors like whether you want a managed or passive investment, the industry focus, whether you prefer growth, value, or dividend stocks, the types of securities (stocks, bonds, REITs, commodities, etc.), and the size of the companies in the portfolio.
There are three main types of investment funds: open-end funds, closed-end funds, and unit investment trusts (UITs). Although all of them manage money for individual investors, pension funds, and employer-matched IRAs and 401(k)s, each type has distinct structures and features.
Open-end funds are the most common type. They can buy and sell an unlimited number of shares, and they can issue and repurchase shares at any time. You buy shares directly from the fund and redeem them in the same way. This setup enhances fluidity and liquidity, but there is no secondary market for these shares. Open-end funds may close to new investors if they become too large to manage effectively. These funds typically focus on specific industries like biotech, technology, energy, consumer staples, or healthcare.
Open-end funds come in load and no-load varieties. A load is a commission fee charged either at the time of purchase or sale of the shares.
– **A Shares**: The load is paid upfront. If you invest $20,000 with a 5% load, $1,000 goes to fees, and you invest the remaining $19,000.
– **B Shares**: The load is deferred until you sell your shares, and the percentage decreases the longer you hold them, becoming zero after a specific period. These tend to have higher annual fees.
– **C Shares**: These combine features of A and B shares. They have a lower upfront load and a load upon sale, with higher annual administrative fees, making them suitable for investors holding shares for at least two years.
Open-end funds are priced both by their net asset value (NAV) and their public offering price (POP). The NAV, updated daily, doesn’t include load costs, whereas the POP does.
Mutual fund companies also provide investment shares through variable annuities and life insurance policies. While these shares might have different names for regulatory reasons, they are essentially the same as their publicly traded counterparts, managed by the same team with the same objectives.
Closed-end funds issue a limited number of shares which are traded on stock exchanges, akin to stocks. Typically income-focused, they may use leverage to enhance yields, making them riskier. They involve more active management and trade without sales loads or commissions, although you will pay a brokerage fee for transactions.
ETFs, a type of closed-end fund, are not actively managed and trade daily like stocks. Their portfolios usually remain fixed, resulting in lower fees compared to other mutual funds.
UITs hold a mix of both closed and open-end fund qualities. They issue a set number of units that are usually not actively managed. Units are purchased from the issuer and held for a fixed period after which the trust dissolves and distributes funds back to investors. Returns are taxable, and sales commissions range from 1% to 5%.
Choosing the right investment depends on your risk tolerance, goals, and investment timeline. Generally, closed-end funds, ETFs, and UITs suit short-term traders, while open-end funds are better for long-term investments. Consulting a professional financial advisor can help determine which investment is best for your needs.
For more on investment funds, explore articles like “My Picks for Vanguard Mutual Funds for Our Roth IRA,” “What are Mutual Funds and How Do I Invest in Them?” and “How to Pick Good Mutual Funds for Your 401k or Retirement Plan.”
