Introduction to Mutual Funds

Meaning Of Mutual Fund

Investing has become a big topic over recent months, and especially mutual funds have been shifted into the public spotlight. There seems to be a lot of confusion about these funds though, as many people do not seem to know what exactly mutual funds are or what they do. We will try our best to give you some insight and answer these questions.

Usually, when people talk about these funds, they are referring to a professionally managed collective investment scheme that is an amassment of money from a variety of investors which is invested into a verity of investment securities such as stocks, bonds, or commodities (mostly precious metals). Now, the big question is what mutual fund is?

Mutual funds are those professionally managed investment pools that, in a way, show the performance of several varied securities like stocks, bonds, and shares. An advisory firm usually organizes them to offer the fund's shareholders a specific investment goal.

With this, investors can buy shares of a mutual fund, for instance, the stock of a company. Anyone buying shares in the fund become a part owner and want to take part often because of those investment goals. To manage the company, the shareholders choose a board of directors to oversee the operations of the business and the portfolio.

Most of the time, the value of these mutual funds are calculated once a day, and that is based on what the fund's current net asset value is. For instance, a real estate mutual funds are one that invests in the real estate securities from around the world.

The real estate mutual funds usually tend to concentrate the investing strategy on the real estate investments trusts and real estate companies. These real estate investments trusts are mostly companies that purchase and manage real estate with help from the funds that were collected from the investors.

Mutual funds raise the money by selling shares of the fund to the public, much like any other company can sell its stock to the public. Funds then take the money they receive from the sale of their shares (along with any money made from previous investments) and use it to purchase various investment vehicles such as stocks, bonds, and money market instruments.

Most investors pick mutual funds based on recent fund performance, the suggestion of a friend, and the praise bestowed on them by a financial magazine or fund rating agency. While using these methods can lead one to select a quality fund, they can also lead you in the wrong direction and wondering what happened to that "great pick."

The history is a good indicator, though not a guarantee that a fund will do well. If you are investing long-term, the history will be of more importance than in a short-term situation as they say lightning rarely strikes the same place twice.

History of Mutual Funds

The first "pooling of money" for investments was done in 1774. After the 1772-1773 financial crisis, a Dutch merchant Adriaan van Ketwich invited investors to come together to form an investment trust. The goal of the trust was to lower risks involved in investing by providing diversification to the small investors. The funds invested in various European countries such as Austria, Denmark, and Spain. The investments were mainly in bonds, and equity formed a small portion. The trust was named Eendragt Maakt Magt, which meant "Unity Creates Strength."

The fund had many features that attracted investors:

• It had an embedded lottery.

• There was an assured 4% dividend, which was slightly less than the average rates prevalent at that time. Thus the interest income exceeded the required payouts, and the difference was converted to a cash reserve.

• The cash reserve was utilized to retire a few shares annually at 10% premium, and hence the remaining shares earned a higher interest. Thus the cash reserve kept increasing over time - further accelerating share redemption.

• The trust was to be dissolved at the end of 25 years, and the capital was to be divided among the remaining investors.

However, a war with England led to many bonds defaulting. Due to the decrease in investment income, share redemption was suspended in 1782, and later the interest payments were lowered too. The fund was no longer attractive for investors and faded away.

After evolving in Europe for a few years, the idea of mutual funds reached the US at the end of the nineteenth century. In the year 1893, the first closed-end fund was formed. It was named the "The Boston Personal Property Trust."

The Alexander Fund in Philadelphia was the first step towards open-end funds. It was established in 1907 and had new issues every six months. Investors were allowed to make redemptions.

The first true open-end fund was the Massachusetts Investors' Trust of Boston. Formed in the year 1924, it went public in 1928. 1928 also saw the emergence of first balanced fund - The Wellington Fund that invested in both stocks and bonds.

The concept of Index based funds was given by William Fouse and John McQuown of the Wells Fargo Bank in 1971. Based on their concept, John Bogle launched the first retail Index Fund in 1976. It was called the First Index Investment Trust. It is now known as the Vanguard 500 Index Fund. It crossed 100 billion dollars in assets in November 2000 and became the World's largest fund.

Today mutual funds have come a long way. Nearly one in two households in the US invests in mutual funds. The popularity of mutual funds is also soaring in developing economies. They have become the preferred investment route for many investors, who value the unique combination of diversification, low costs, and simplicity provided by the funds.

Structure of Mutual Funds

The mutual fund industry is highly regulated to imparting operational transparency and protecting the investor's interest. It is usually either a corporation or a business trust.

Like any corporation, a mutual fund is owned by its shareholders. Virtually all mutual funds are externally managed; they do not have employees of their own. Instead, their operations are conducted by affiliated organizations and independent contractors

Understanding The Types Of Mutual Funds

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