Tahoe-Truckee Market Beat: The different types of mutual funds
The first modern mutual fund was the Massachusetts Investors Trust, which was created in 1924. Mutual funds have evolved considerably in the last 93 years. Today there are several different types of funds, and it is important for investors to understand them and how they work.
Massachusetts Investors Trust is known as an open end fund. If you purchase shares of an open end fund, the fund company will create new shares of the fund, and they trade once per day. So, if you place an order to buy or sell you’ll get the price at the end of the day.
Open end funds come in two basic types, load and no-load. Loaded funds will charge a commission in addition to the ongoing fund expenses.
No-load funds charge no commission but will also have an expense ratio. Managed funds typically have a higher expense ratio than passive funds. Passive funds will track an index like the S&P 500 and have lower costs. Annual fees for an index fund might be fifteen basis points or less. Fifteen basis points is 0.15% per year.
Closed end mutual funds have a set number of shares issued and trade on the market similar to a stock. Closed end funds will trade at either a premium or a discount to their NAV or net asset value. With a closed end fund your broker will get a commission when you buy or sell and it will also have an annual expense.
Exchange traded funds are relatively new; the first ones were created just over twenty years ago and they have exploded in popularity.
Two basic types are exchange traded funds and exchange traded notes. Both of them trade actively throughout the day like stocks. There are passive and actively managed exchange traded funds. The passive index funds will have very low expense ratios like passive open end mutual funds.
The difference between exchange traded funds, ETFs, and exchange traded notes, ETNs, is that the ETNs are backed by the credit quality of the issuing bank. Equity ETFs are backed by the underlying shares of stock. So, an index ETF that tracks the S&P 500 index will buy the shares of the companies in the index and hold them. An ETN might be based on futures or other derivatives contracts.
It’s important to understand the type of fund you’re invested in and know how much you pay in expenses.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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