Understanding Mutual Funds

One of the most popular ways to achieve your investment objectives is with mutual funds. Mutual funds are a great way to get started in investing and can continue to play an important role in your portfolio throughout your life. Here, the California Society of CPAs (www.calcpa.org) provides some basic information to help you understand how mutual funds work.

A mutual fund is a portfolio of stocks, bonds, or money market funds that is managed on behalf of many investors who share ownership. Each fund has an investment objective and a professional manager. With a mutual fund, investors can attain a diversified portfolio for much less than they could by buying individual stocks and bonds.

Most mutual funds require an initial investment of at least $1,000 or, in some cases, less if you agree to make regular monthly investments. Mutual funds are very liquid, meaning that you can easily convert them into cash at their current market value should the need arise, and making additional deposits is simple. Most mutual funds offer automated reinvestment programs, and some will even arrange for automatic periodic payouts if you want regular income.

Closed-End vs. Open-End

All funds are either open-end or closed-end funds. In an open-end fund, the most common variety, there is no limit to the number of shares that can be issued. On an ongoing basis, new shares are available to both existing and new investors. Open-end funds typically are bought and sold directly through the fund company. By contrast, a closed-end mutual fund issues only a fixed number of shares that must be bought through a broker at a price that fluctuates in response to the fund's performance and investor demand.

Net Asset Value

The net asset value, or NAV, is the dollar value of one share in the fund and represents the price at which you can buy and sell shares. A fund's NAV is calculated at the end of every trading day by dividing the number of shares outstanding into the total value of the portfolio.

Types of Stock Funds

There are three major categories of mutual funds ‹ stock, bond, and money market. Each has a primary investment strategy.

The stock category includes many types of growth funds, which focus on stocks that show capital appreciation. Income funds are for investors whose primary objective is income, while balanced funds balance growth and income. Then there are sector funds, which invest in a particular sector such as technology or health care, and index funds that buy shares of every stock in a particular index, such as the S&P 500. With socially responsible funds, investors support those companies that best match their personal beliefs and values.

Global funds invest in companies both around the world and domestically. International funds buy only foreign securities while regional funds concentrate on markets in one part of the world such as Latin America or Europe.

There are also numerous types of bond funds. These range from the most conservative that invest primarily in government bonds to those that specialize in junk bonds.

Finally, money market mutual funds have become useful both as a cash management tool and as a place to "park" funds between investments.

Sales Charges

A mutual fund may be either a load or a no-load fund. A load mutual fund charges you for the number of shares you buy plus a sales fee or commission. The fee, called a sales load, may be charged for buying into the fund (a front-end load) or selling the fund (a back-end load). This fee varies, but is usually in the range of 3 to 8 percent of the purchase price, with most funds charging about 5 percent. A no-load fund sells its shares without a commission or sales charge.

Management Expenses

To cover the cost of management and other expenses, all mutual funds charge an annual administrative fee of 0.5 percent or more.

Before You Buy

Every mutual fund issues a prospectus, which describes the fund's investment policies and objectives, risks, costs, historical performance data, and other pertinent information. CPAs recommend that you carefully read the prospectus before you invest in any fund.