What is a Mutual Fund?
A mutual fund is an actively managed investment company that pools money from individuals and institutions who share a common financial goal. Professional money managers buy a portfolio of securities they think will help investors achieve their goals. Portfolios typically consist of stocks, bonds and money-market instruments or a combination of these investments.
Investors buy shares of the mutual fund, each share representing proportional ownership in all of the fund's underlying securities. The share price, or net asset value (NAV), is determined at the end of each business day by adding up the value of all the securities in the fund's portfolio after expenses and dividing the sum by the total number of outstanding shares.
Most mutual funds are "open-end" funds, meaning the fund sells as many shares as investors want to buy. Investors may buy or redeem shares from the fund each business day.
| The Mutual Fund Advantage |
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There are four attributes of mutual funds that can work to your advantage:
1. DIVERSIFICATION
By pooling investors' money, a mutual fund may purchase securities from many, often hundreds, of different issuers, dramatically reducing the risk that problems or losses in any one company will hurt the overall portfolio. Most investors probably would never be able to match this level of diversification on their own.
2. PROFESSIONAL MANAGEMENT
Professional money managers' decisions to buy and sell are based on extensive and ongoing research into individual companies, combined with analysis of economic and market trends. Few individual investors have the time or resources to manage a sizable portfolio on a daily basis or stay current on the thousands of securities available in financial markets.
3. LIQUIDITY
You may sell some or all of your mutual fund shares at any time and receive the current value of your shares (net asset value), which may be more or less than their original cost.
Mutual funds offer shareholders many services that make investing easier. You usually can:
Exchange money between funds within the same fund family as your investment goals change.
Add to your account electronically, for example, by transferring a set dollar amount from your savings or checking account into your mutual fund account each month.
Redeem shares automatically to help meet monthly expenses.
Choose to have distributions of fund income paid to you by check, transferred into your bank account or automatically reinvested in more shares of the fund.
Buy or sell shares by telephone or mail.
| How Mutual Funds Work for You |
Most mutual funds pursue growth of capital, income or some combination of the two. Before we discuss how to match mutual funds with your objectives, let's look at how mutual funds use their assets to earn more money.
| The Building Blocks Of Growth |
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A mutual fund's investment goal and the securities in its underlying portfolio determine how it can make money.
Understanding How Mutual Funds Make Money
It's important to know that mutual funds can earn money for shareholders in a number of ways - and that there are tax consequences and reinvestment options that should be considered.
Dividends and Interest Payments
Dividends from stocks and interest from bonds held in mutual fund portfolios are typically paid out monthly or quarterly to shareholders.
Capital Gains
When securities are sold from the portfolio at a profit. Short-term capital gain applies to securities held less than 12 months. A long-term capital gain applies to securities held more than 12 months.
Fund Price Rises
The fund price, or net asset value (NAV), rises when the value of the securities in the mutual fund portfolio rise.
Tax-Exempt Income and Tax-Deferred Growth
Tax-Exempt: Some funds, such as tax-exempt municipal bond funds, pay income that is free from federal income tax (and, in some cases, from state and local income taxes).
Tax Deferred: Funds held in a qualified retirement account, such as an IRA or a 401(k), allow you to enjoy years of growth that is not taxed until funds are withdrawn (during retirement, for example). |
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Dividend and interest distributions are taxed as ordinary income - rates as high as 39.6%.
Short term gains are taxed as ordinary income. Long-term gains are taxed at 10% for investors in the 15% tax bracket and taxed at 20% for those in all higher brackets.
Capital gains taxes apply when you sell your shares.
Tax-Exempt: Most investors will owe no income tax on income paid out to them by their tax-exempt mutual funds (unless they are subject to the federal alternative minimum tax).
Tax-Deferred: When funds are withdrawn (usually at age 59 or later), they are treated as taxable income and are taxed at the applicable income tax rate for each investor. Withdrawals prior to age 59 may subject investors to tax obligations, including a 10% penalty, and upon withdrawal your investment may be worth more or less than its original cost. |
Understanding Risk
Investing involves an unavoidable tradeoff between investment performance and risk. Market risk exists because stock and bond prices fluctuate. In general, the higher the return you hope to achieve, the more risk you must be willing to assume. Of course, no one is going to complain when the value of a mutual fund skyrockets. The real risk is that your investment's value will fall.
Stocks have provided the highest, long-term returns of the three major asset classes, and have been subject to the biggest losses over shorter periods. Bonds have experienced less fluctuation, but lower long-term returns. Short-term money-market instruments are among the safest of investments when it comes to price stability, but they have provided the lowest, long-term total returns.
Asset Allocation: Creating a Custom Mix
Asset allocation, or the strategy of investing your assets among stock, bond and cash securities, optimizes the balance between the amount of risk you want to take and the returns you need to meet your long-term financial goals.
Mutual funds provide one of the most convenient ways of diversifying your assets among the three different asset classes. By using asset allocation with the help of a professional investment representative, you can tailor a portfolio to your investment objective, time horizon, risk tolerance and current financial circumstances.
Call your Janney Financial Consultant for your asset allocation mix or click here.
For information on how Janney Montgomery Scott LLC can help you and your loved ones meet those needs, click here.
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What is a Mutual Fund? 
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