Mutual Funds: Pros/Cons, Costs, & Growth Potential
In the ever-changing financial industry, there are numerous asset classes. Once you study into an asset class, there are additional sub asset classes that can be derived; this list can run on infinitely. In the asset class of equity securities, you find Mutual funds. A Mutual fund collects funds from several investors and invests them in a potentially wide range of assets and securities. It’s a simple concept that dates back to the 1700’s. It is hard to trace the first mutual fund, but it is said to have originated in the Netherlands sometime in 1774. Mutual funds pool investors funds together and invest in large blocks of securities that one investor would usually not be able to carryout by themselves. Although there are advantages and disadvantages to Mutual funds, over one half of U.S. households held mutual funds in their portfolio currently in 2014. Mutual funds are very popular because it doesn’t require an investor to be an expert on each individual stock in the fund; instead, the investor gets a bundle of stocks in a sector or industry he/she hand picks.
As I mentioned earlier, mutual funds date back to the late 1700s, but they actually were introduced to the U.S. in 1983. One of the first closed funded mutual funds in America was The Boston Personal Property Trust. Mutual funds can be either closed or open-end funds. Mutual funds at its commencement were only closed-end funds; there were a limited amount of shares available in the mutual fund, and the shares were traded only with other shareholders of the fund. (“Investment,”n.d., para. 1). Liquidity was a huge issue, as you could not trade a closed-end mutual fund unless you were one of the original shareholders at the funds start. Once the fund was traded, it was closed. The Security & Exchange Commission (SEC) act of 1934 set initial standards for Mutual funds, and the U.S. Securities and Exchange Commission required to register with them and to provide disclosure in the form of a prospectus. Six years later, the Investment Company Act of 1940 clearly set out the limits regarding filings, service charges, financial disclosure and the fiduciary duties of fund companies. This act was a result of the 1929 stock market crash and established to stabilize financial markets. As time passed and investors sought after more liquidity in mutual funds, open-ended funds were created. An open-ended fund has an infinite number of shares and trades are not made directly to other shareholders; shares that were up for sale were sold back to the fund and new investors bought shares directly from the fund. The Net Asset Value (NAV) of the mutual fund derived the value of an open-end fund. Why is there a NAV? In an open-end fund, each investor owns a portion of the fund and this value must be calculated as a representation of the funds overall value. Taking the market value of the funds securities, subtracting the funds liabilities, and dividing the result by the number of shares outstanding calculates NAV. A distinctive characteristic of open-end funds is the end of day trading calculation. Due to the fluctuation during trading hours, NAV is only calculated at the end of the trading day. An investor must hold his shares in an open-end fund until NAV can be calculated before he can sell back to the fund. This means that an investor must patiently watch his shares rise or fall before selling. Open-end funds became very popular and most mutual funds will be open-ended in today’s market. According to Morningstar, there are currently 7,467 open-end funds with total net assets of $12.1 trillion. According to the Investment Company Institute (ICI) there were 56.7 million households and 46.3% of households with mutual funds in 2013. You don’t need a large substantial amount of capital to get a mutual fund, hence the widespread popularity. Mutual funds are purchased through a fund company, supermarket, or a human broker. A fund company
