Mutual fund basics

Published 11:15 am Saturday, December 2, 2017

by Meghan Councill

I want to cover another popular investment vehicle: mutual funds. Let’s start with some vocabulary important to this discussion. Mutual funds can be open-end, which means there is no limit to the possible number of shares outstanding. You buy from the fund company, which takes your cash to invest and issues you new shares of the fund. You also sell your shares to the fund company, which takes your shares back and gives you cash out of the fund. Open-end funds are priced after the market closes based on the Net Asset Value (NAV.) NAV = (Total Value of Securities – Liabilities)/ Total # of Outstanding Shares.

Mutual funds can also be closed-end, which means the number of shares outstanding is limited. You buy and sell the shares from other investors (not the fund company) similar to how you would buy and sell public stocks. Closed-end funds are priced by the market of what buyers are willing to pay and sellers are willing to accept for that portfolio of securities, so sometimes there is a mismatch between the market price and the NAV.

Mutual funds can be actively or passively managed. Active managers normally try to beat a given passive benchmark. This means they try to outperform through higher returns or better performance.  Active managers can manage your money in a Separately Managed Account (SMA) in which you own the underlying securities and have some ability to customize the holdings or in a mutual fund in which your money is pooled with other investors’ money, thereby giving you ownership in shares of the mutual fund with no ability to customize the underlying holdings.

Think of a separately managed account as one in which you would own all the ingredients to a pie; the flour, sugar, butter, berries, etc., you own each individually. With a mutual fund, the pie is already made with those ingredients, you own a slice of the pie. Mutual funds are usually available to investors at far lower initial investment minimums than separately managed accounts.

There are several costs associated with mutual funds. The load is the sales charge paid to your Financial Advisor. It is deducted from the amount invested and can be very different from fund to fund.  The expense ratio is the cost to operate the fund and includes charges from administration, management, accounting, audit and 12b-1 fees. These are annual marketing and distribution fees paid to financial advisors.  Funds also incur internal trading commissions (costs of trading the underlying securities) that are not included in the expense ratio. Some funds may also have a redemption fee, which is typically charged when a fund is sold within one year (typically 1 percent.)

Mutual funds also have different share classes, which indicate the nature of fees charged. While there are all kinds of share classes, (one American Fund has 18 different share classes) there are three primary types available in a taxable account. A-Shares have “front-end loads” which means the financial advisor is paid up front. C-Shares have “level loads” which mean the financial advisor is paid a certain amount each year. No loads have no load and no (or low) 12b-1 fees. No loads are typically purchased directly from the fund or an advisor charges a separate wrap fee or hourly rate to get paid.

The mutual fund universe has expanded drastically and as of last year there were over 9,000 funds available in the U.S. Each fund has different costs, characteristics, risks and each should be evaluated before making a purchase so that the choice can meet your investment needs.

An investor should consider the fund’s investment objectives, risks and charges and expenses carefully before investing. The fund’s prospectus contains this and other important information. You may obtain a copy of the fund’s prospectus by calling your financial advisor. Investors should read the prospectus carefully and discuss their goals with a qualified investment professional before deciding to invest.

The information provided is for information purposes only and should not be considered an individual recommendation or personalized investment advice. Each investor needs to review his or her particular situation. Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed. Investing in stocks and the equities market always carries risk. Equities are subject generally to market, market sector, market liquidity, issuer and investment style risks, among other factors, to varying degrees.

The statements and opinions expressed in this article are those of the authors as of the date of the article, are subject to rapid change as economic and market conditions dictate, and do not necessarily represent the views of Davenport & Company LLC. This information may contain forward looking predictions that are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. This article does not constitute investment advice, is not predictive of future performance, and should not be construed as an offer to sell or a solicitation to buy any security or make an offer where otherwise unlawful. Investing always carries risk.

MEGHAN COUNCILL is a Registered Representative with Davenport & Company LLC. Member NYSE-SIPC-FINRA