Most mutual fund buyers are not sophisticated investors and invest because:
funds are available through a
retirement plan like the IRA, Roth IRA, or 401(k)
funds seem safer than
individual stocks (they are)
they were told that funds are
the best way to diversify (true)
brokers or investment
advisers have talked them into it, or
aggressive advertising
convinced them
Many mutual fund investors do not like doing their homework, and therefore
do not know what they are getting into. A prospectus, even a simplified one,
intimidates them, and they probably do not read them carefully, if at all.
The next time a mutual fund salesperson approaches and lures you into
investing, ask for the prospectus and study it. Here is what you look for.
Fund Structure: Open-ended or Closed-end
Mutual funds are registered investment companies that collect funds from
investors – individuals like you and institutions like banks, pension funds,
and insurance companies – and invest the funds in stocks, bonds, and money
market instruments. The amount you invest determines how many shares you own.
Mutual funds can have two structures: open-ended or closed-end.
The main difference between the two is that open-ended funds can accept new
investors and issue more shares, while closed-end funds have a fixed number of
shares.
In an open-ended mutual fund, the company is required to redeem
outstanding shares at any time, upon demand, and at a price determined by the
current value of the fund’s net assets, or the net asset value (NAV). There are
over 10,000 mutual funds, accounting for investments of around $7 trillion from
83 million investors.
In a closed-end mutual fund, the company issues a fixed number of
shares and uses the fund to buy and hold a fixed portfolio of stocks, bonds, or
other securities. The fund has a stated date for termination, upon which
investors receive their proportionate share of net assets. There are around 800
closed-end funds with total investments of $371 billion.
Open-ended funds are convertible to cash (more liquid) more easily than
closed-end funds and have lower costs and fees. Returns of closed-end funds,
however, may be higher because of the higher risk. Open-ended funds are safer
investments.