Mutual Funds Vs. Investment Companies

by Herb Kirchhoff

A mutual fund isn’t an alternative to an investment company, just as a Chevrolet sedan isn’t an alternative to an automobile company. Mutual funds actually are one of four general types of investment company products. The others are exchange-traded funds, closed-end funds and unit-investment trusts. However, mutual funds are by far the biggest frog in the investment company pond, managing 90 percent of the $13.1 trillion in assets entrusted to investment companies in 2010.

What They Do

Investment companies manage financial assets entrusted to them by households, businesses, pension funds and other entities. The objective of investment company money managers is to earn a good return for their investors on the assets they manage. Investment companies collectively are among the largest players in U.S. financial markets. As of the time of publication, they owned 27 percent of all U.S. corporate stock, 13 percent of corporate bonds, 45 percent of commercial paper, 33 percent of municipal bonds, and 13 percent of U.S. government securities. They managed 23 percent of household financial assets and 54 percent of retirement plan assets. Investors acquire shares in investment companies through brokers and advisers.

Mutual Funds

A mutual fund pools money from thousands of investors. The fund’s managers use this pool of money to buy stocks, bonds and other securities. Mutual funds offer a far more diversified investment portfolio than you could put together for yourself. Mutual fund shares sell for a price based on the total value of the securities owned by the fund, divided by the number of shares outstanding. The price of mutual fund shares changes once per day, in line with changes in the total value of the fund’s securities. Mutual funds pursue different investment strategies. Some look for dividend income, others for capital gains and still others try to balance income and capital gains. Some funds specialize in a specific economic sector, like health care.

Exchange Traded Funds

An exchange traded fund is made up of a basket of securities that tracks a market index like the Standard & Poor's 500. Some ETFs may also incorporate stocks picked by investment managers or by mathematical models. Shares in an ETF trade, like stocks and their prices, vary throughout the trading day. Unlike with mutual fund shares, ETF shares can be sold short and bought on margin. Investors use ETFs for making bets on economic trends or for hedging against adverse market moves. In 2010, ETFs accounted for 7 percent of all investment company assets.

Other Funds

A closed-end fund works somewhat like a mutual fund except that it limits the number of shares available to investors and doesn’t buy back its own shares. Typically, these funds have a one-time initial public offering of shares, which then trade on the secondary market like mutual fund shares. The fund doesn’t issue any new shares. A unit investment trust resembles a closed-end fund except that it can buy back and resell its shares, has a fixed dissolution date and doesn’t trade its securities but instead holds them for the lifetime of the fund. These two types of funds together accounted for 3 percent of all investment company assets as of 2010.

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