Mutual Fund Investing
Morgan Wilshire Securities, Inc. has found that investing in mutual funds has become a popular way to invest in securities since they can provide built-in diversification, professional management and offer an advantage over purchasing individual stocks and bonds, but they also have certain risks, including the possibility that you may lose your investment funds. A mutual fund is an investment company that collects money from numerous investors and then invests the 'funds' based on specific investment goals determined by its objectives and the investment style and skill of the professional manager(s).
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Types of Investment Risk
How Mutual Funds Work
Owning shares in a mutual fund allows an investor to share in its profits through income and capital gains distributions after all expenses have been satisfied. Investors have the option of receiving the distributions in cash or they can have them automatically reinvested in the fund to increase the number of shares they own. It should also be understood that investors must pay taxes on the mutual fund's income distributions and usually on its capital gains if the fund is in a taxable account. However, if you own the mutual fund in a tax-deferred or tax-free account, such as an individual retirement account, no tax is due on any of these distributions when you receive them. But you will owe tax at your regular rate on all withdrawals from a tax-deferred account. The investments a fund will make is determined by the funds objectives and, in the case of an actively managed fund, by the investment style and skill of the mutual fund's professional manager or managers. The holdings of the mutual fund are known as its underlying investments, and the performance of those investments, minus fund fees, determine the fund's investment return.
Morgan Wilshire Securities understands that there are literally thousands of individual mutual funds. However, the major fund categories are listed below:
- Stock funds invest in stocks.
- Stock funds include: Growth, Value, Equity Income, Stock Index, etc.
- Bond funds invest in bonds.
- Bond funds include: Corporate, Agency or Municipal, Short or Intermediate, Treasury and High-Yield
- Balanced funds invest in a combination of stocks and bonds.
- Money market funds invest in very short-term investments, also known as cash equivalents.
Morgan Wilshire Securities wishes investors to understand that funds and fund managers will not always invest 100 percent of their assets in accordance with the investment strategy stated as part of their objectives. This is called "style drift", which occurs when the fund manager invests a portion of the funds assets in a category that the fund would normally exclude. While fund managers will make this type of investment adjustment to compensate for lagging performance, it must be understood that this has the possibility of exposing investors to risks they are not prepared for. The Securities and Exchange Commission (SEC) has issued rules that require a mutual fund must invest at least 80 percent of its assets in the type of investment suggested by its name. However, mutual funds are still allowed to invest up to one-fifth of their holdings in other types of securities which can include securities that investors may consider too risky or perhaps not aggressive enough. Morgan Wilshire recommends that our clients review the latest quarterly report showing the fund's major investment holdings and to ensure how closely the fund manager is following the mutual funds strategy mentioned in the prospectus.
Open-End and Closed-End Fund Differences
Open-end funds allow investors to buy and sell shares at any time. They create new shares to meet demand for increased sales and buy back shares from investors who sell. This is one of the key distinguishing features of an open-end fund. Open-end funds get so large that they can be closed to new investors. If an open-end fund is closed, it still remains an open-end fund since existing shareholders can continue to buy and sell fund shares.
An open-end fund will calculate the value of one share, which is the net asset value (NAV) once per day after the markets have closed. The funds NAV is not a measure of a fund's success since open-end funds can issue new shares and buy back old ones all the time, the number of shares and the dollars invested in the fund are constantly changing. When an investor wishes to compare two or more mutual funds it is more beneficial to the investor to review the total return over time of the open-end funds than to compare the NAV of the funds.
Closed-end funds differ from open-end funds because they raise money only once in a single offering at its initial public offering, or IPO. After the shares are sold, the closed-end fund will use the invested funds to purchase a portfolio of underlying investments, and any further growth in the size of the fund depends on the return on its investments. The fund is then listed on an exchange, the way an individual stock is, and shares trade throughout the day. Investors can buy or sell shares of a closed-end fund by placing an order with their investment advisor. A closed-end fund price will rise and fall in response to investor demand and may be higher or lower than the funds NAV or the actual per-share value of the fund's underlying investments.
Exchange-Traded Fund (ETF) Investing
An ETF, or exchange-traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold.
ProShares: Nine Questions Every ETF Investor Should Ask Before Investing
Morgan Wilshire Securities, Inc. is available to help you sort through the information about mutual fund investment and assist you in determining what may be appropriate for your specific objectives.
Please consult your Morgan Wilshire representative to better understand the potential risks and rewards of any investment.