What is MUTUAL FUNDS? How it can be used to become WEALTHY?

Mutual fund

A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities. These investors may be retail or institutional in nature.

Mutual funds have advantages and disadvantages compared to direct investing in individual securities. The primary advantages of mutual funds are that they provide economies of scale, a higher level of diversification, they provide liquidity, and they are managed by professional investors. On the negative side, investors in a mutual fund must pay various fees and expenses.

Primary structures of mutual funds include open-end funds, unit investment trusts, and closed-end funds. Exchange traded funds  (ETFs) are open-end funds or unit investment trusts that trade on an exchange. Mutual funds are also classified by their principal investments like money market funds, bond or fixed income funds, stock or equity funds, hybrid funds or other. Funds may also be categorized as index funds, which are passively managed funds that match the performance of an index or actively managed funds. Hedge Funds are not mutual funds; hedge funds cannot be sold to the general public and are subject to different government regulations.

Mutual funds today

At the end of 2016, mutual fund assets worldwide were $40.4 trillion, according to the Investment Company Institute. The countries with the largest mutual fund industries are:

1. United States: $18.9 trillion
2. Luxembourg: $3.9 trillion
3. Ireland: $2.2 trillion
4. Germany: $1.9 trillion
5. France: $1.9 trillion
6. Australia: $1.6 trillion
7. United Kingdom: $1.5 trillion
8. Japan: $1.5 trillion
9. China: $1.3 trillion
10. Brazil: $1.1 trillion

In the United States, mutual funds play an important role in U.S. household finances. At the end of 2016, 22% of household financial assets were held in mutual funds. Their role in retirement savings was even more significant since mutual funds accounted for roughly half of the assets in individual retirement accounts, 401(k)s and other similar retirement plans. In total, mutual funds are large investors in stocks and bonds.

Luxembourg and Ireland are the primary jurisdictions for the registration of UCITS funds. These funds may be sold throughout the European Union and in other countries that have adopted mutual recognition regimes.

Advantages and disadvantages to investors

Advantages

• Increased diversification: A fund diversifies holding many securities. This diversification decreases risk.
• Daily liquidity: Shareholders of open-end funds and unit investment trusts may sell their holdings back to the fund at regular intervals at a price equal to the net asset value of the fund's holdings. Most funds allow investors to redeem in this way at the close of every trading day.
• Professional investment management: Open-and closed-end funds hire portfolio managers to supervise the fund's investments.
• Ability to participate in investments that may be available only to larger investors. For example, individual investors often find it difficult to invest directly in foreign markets.
• Service and convenience: Funds often provide services such as check writing.
• Government oversight: Mutual funds are regulated by a governmental body.
• Transparency and ease of comparison: All mutual funds are required to report the same information to investors, which makes them easier to compare to each other.

Disadvantages

Mutual funds have disadvantages as well, which include:

• Fees
• Less control over the timing of recognition of gains
• Less predictable income
• No opportunity to customize

Classification of funds by types of underlying investments

Mutual funds are normally classified by their principal investments, as described in the prospectus and investment objective. The four main categories of funds are money market funds, bond or fixed income funds, stock or equity funds, and hybrid funds. Within these categories, funds may be sub-classified by investment objective, investment approach or specific focus.

The types of securities that a particular fund may invest in are set forth in the fund's prospectus, a legal document which describes the fund's investment objective, investment approach and permitted investments. The investment objective describes the type of income that the fund seeks. For example, a capital appreciation fund generally looks to earn most of its returns from increases in the prices of the securities it holds, rather than from dividend or interest income. The investment approach describes the criteria that the fund manager uses to select investments for the fund.

Bond, stock, and hybrid funds may be classified as either index (or passively-managed) funds or actively managed funds.

Money market funds

Money market funds invest in money market instruments, which are fixed income securities with a very short time to maturity and high credit quality. Investors often use money market funds as a substitute for the bank savings account, though money market funds are not insured by the government, unlike bank savings accounts.

In the United States, money market funds sold to retail investors and those investing in government securities may maintain a stable net asset value of $1 per share, when they comply with certain conditions (alternately, money market funds must compute a net asset value based on the value of the securities held in the funds).

In the United States, at the end of 2016, assets in money market funds were $2.7 trillion, representing 14% of the industry.

Bond funds

Bond funds invest in fixed income or debt securities. Bond funds can be sub-classified according to:

• The specific types of bonds owned (such as high-yield or junk bonds, investment-grade, corporate bonds, government bonds or municipal bonds)
• The maturity of the bonds held (i.e., short-, intermediate- or long-term)
• The country of issuance of the bonds (such as U.S., emerging market or global)
• The tax treatment of the interest received (taxable or tax-exempt)

In the United States, at the end of 2016, assets in bond funds were $4.1 trillion, representing 22% of the industry.

Stock funds

Stock, or equity, funds invest in common stocks. Stock funds may focus on a particular area of the stock market, such as

• Stocks from only a certain industry
• Stocks from a specified country or region
• Stocks of companies experiencing strong growth
• Stocks that the portfolio managers deem to be a good value relative to the value of the company's business
• Stocks paying high dividends that provide income
• Stocks within a certain market capitalization range

In the United States, at the end of 2016, assets in Stock funds were $10.6 trillion, representing 56% of the industry.

Hybrid funds

Hybrid funds invest in both bonds and stocks or in convertible securities. Balanced funds, asset allocation funds, target date or target risk funds, and lifecycle or lifestyle funds are all types of hybrid funds.

Hybrid funds may be structured as funds of funds, meaning that they invest by buying shares in other mutual funds that invest in securities. Many funds of funds invest in affiliated funds (meaning mutual funds managed by the same fund sponsor), although some invest in unaffiliated funds (i.e., managed by other fund sponsors) or some combination of the two.

In the United States, at the end of 2016, assets in hybrid funds were $1.4 trillion, representing 7% of the industry.

Other funds

Funds may invest in commodities or other investments.

Expenses

Investors in a mutual fund pay the fund's expenses. Some of these expenses reduce the value of an investor's account; others are paid by the fund and reduce net asset value.

These expenses fall into five categories:

Management fee

The management fee is paid by the fund to the management company or sponsor that organizes the fund, provides the portfolio management or investment advisory services and normally lends its brand to the fund. The fund manager may also provide other administrative services. The management fee often has breakpoints, which means that it declines as assets (in either the specific fund or in the fund family as a whole) increase. The fund's board reviews the management fee annually. Fund shareholders must vote on any proposed increase, but the fund manager or sponsor can agree to waive some or all of the management fee in order to lower the fund's expense ratio.

Index funds generally charge a lower management fee than actively-managed funds.

Distribution Charges

Distribution charges pay for marketing, distribution of the fund's shares as well as services to investors. There are three types of distribution charges.

• Front-end load or sales charge. A front-end load or sales charges is a commission paid to a broker by a mutual fund when shares are purchased. It is expressed as a percentage of the total amount invested or the "public offering price", which equals the net asset value plus the front-end load per share. The front-end load often declines as the amount invested increases, through breakpoints. The front-end load is paid by the investor; it is deducted from the amount invested.
• Back-end load. Some funds have a back-end load, which is paid by the investor when shares are redeemed. If the back-end load declines the longer the investor holds shares, it is called a contingent deferred sales charges (CDSC). Like the front-end load, the back-end load is paid by the investor; it is deducted from the redemption proceeds.
• Distribution and services fee. Some funds charge an annual fee to compensate the distributor of fund shares for providing ongoing services to fund shareholders. In the United States, this fee is sometimes called a 12b-1 fee, after the SEC rule authorizing it. The distribution and services fee is paid by the fund and reduces net asset value.

Distribution charges generally vary for each share class.

Securities transaction fees incurred by the fund

A mutual fund pays expenses related to buying or selling the securities in its portfolio. These expenses may include brokerage commissions. These costs are normally positively correlated with the turnover.

Shareholder transaction fees

Shareholders may be required to pay fees for certain transactions, such as buying or selling shares of the fund. For example, a fund may charge a flat fee for maintaining an individual retirement account for an investor. Some funds charge redemption fees when an investor sells fund shares shortly after buying them (usually defined as within 30, 60 or 90 days of purchase). Redemption fees are computed as a percentage of the sale amount. Shareholder transaction fees are not part of the expense ratio.

Fund services charges

A mutual fund may pay for other services including:

• Board of directors or trustees fees and expenses
• Custody fee: paid to a custodian bank for holding the fund's portfolio in safekeeping and collecting income owed on the securities
• Fund administration fee: for overseeing all administrative affairs such as preparing financial statements and shareholder reports, SEC filings, monitoring compliance, computing total returns and other performance information, preparing/filing tax returns and all expenses of maintaining compliance with state blue sky laws.
• Fund accounting fee: for performing investment or securities accounting services and computing the net asset value (usually every day the NYSE is open)
• Professional services fees: legal and auditing fees
• Registration fees: paid to the SEC and state securities regulators
• Shareholder communications expenses: printing and mailing required documents to shareholders such as shareholder reports and prospectuses
• Transfer agent service fees and expenses: for keeping shareholder records, providing statements and tax forms to investors and providing telephone, internet and or other investor support and servicing
• Other/miscellaneous fees

The fund manager or sponsor may agree to subsidize some of these charges.

Expense ratio

The expense ratio equals recurring fees and expenses charged to the fund during the year divided by average net assets. The management fee and fund services charges are ordinarily included in the expense ratio. Front-end and back-end loads, securities transaction fees and shareholder transaction fees are normally excluded.

To facilitate comparisons of expenses, regulators generally require that funds use the same formula to compute the expense ratio and publish the results.

Controversy regarding fees and expenses

Critics of the fund industry argue that fund expenses are too high. They believe that the market for mutual funds is not competitive and that there are many hidden fees so that it is difficult for investors to reduce the fees that they pay. They argue that the most effective way for investors to raise the returns they earn from mutual funds is to invest in funds with low expense ratios.

Fund managers counter that fees are determined by a highly competitive market and, therefore, reflect the value that investors attribute to the service provided. They also note that fees are clearly disclosed.

Market capitalization

Market capitalization equals the number of a company's shares outstanding multiplied by the market price of the stock. Market capitalization is an indication of the size of a company. Typical ranges of market capitalizations are:

• Mega-cap - companies worth $200 billion or more
• Big/large-cap - companies worth between $10 billion and $200 billion
• Mid-cap - companies worth between $2 billion and $10 billion
• Small cap - companies worth between $300 million and $2 billion
• Micro cap - companies worth between $50 million and $300 million
• Nano cap - companies worth less than $50 million

Net asset value

A fund's net asset value (NAV) equals the current market value of a fund's holdings minus the fund's liabilities (this figure may also be referred to as the fund's "net assets"). It is usually expressed as a per-share amount, computed by dividing net assets by the number of fund shares outstanding. Funds must compute their net asset value according to the rules set forth in their prospectuses. Most compute their NAV at the end of each business day.

Valuing the securities held in a fund's portfolio is often the most difficult part of calculating net asset value. The fund's board typically oversees security valuation.

Turnover

Turnover is a measure of the volume of a fund's securities trading. It is expressed as a percentage of average market value of the portfolio's long-term securities. Turnover is the lesser of a fund's purchases or sales during a given year divided by average long-term securities market value for the same period. If the period is less than a year, turnover is generally annualized.