Many Americans invest in mutual funds. Many company-sponsored retirement plans invest in mutual funds. Mutual funds offer the small investor the opportunity to invest in very diverse securities. Mutual funds represent one of three investment company types. Closed-end funds and unit investment trusts comprise the other two types. Trading in mutual funds is not as hard as you might think. As always, consult a licensed professional before investing your hard-earned cash.
Mutual funds come in two types -- open-end funds and closed-end funds. Closed-end funds are not typical and work differently than open-ended funds. Closed-end funds only issue shares one time and trade on the secondary exchange markets after the initial offering. Open-end funds represent the majority of mutual funds on the market. Open-end funds always have new shares available to buy and investors can redeem shares at any time.
When you buy or redeem mutual fund shares, you don’t know the exact transaction price until the close of the business day. Unlike stock prices that can fluctuate throughout the day, mutual fund prices get calculated once per day, at the close of the trading day. Mutual funds use net-asset value or NAV to calculate per share value. To calculate net-asset value, subtract all of the fund’s liabilities from its total assets. Take that figure and divide it by the number of outstanding shares. For example, a company that has $1 billion in assets, $340 million in liabilities and has 30 million outstanding shares has an NAV of $22.00 per share ($1 billion - $340 million) = $660 million / 30 million = $22.00.
When you purchase shares of a mutual fund you purchase them directly from the fund company or through a licensed broker/dealer of the fund. You do not buy them in the secondary market like you do stock. What’s the secondary market? The New York Stock Exchange, NASDAQ and other exchanges act as secondary markets. They trade shares of securities after a company has its initial public offering (considered the primary market). The fund pools your money along with other investors to purchase shares of individual companies. You don’t own shares in each individual company, you simply own shares of the mutual fund.
When you’re ready to sell or redeem your mutual fund shares, it’s as simple as calling your broker. When you redeem mutual fund shares, you basically sell them back to the fund (this creates the infinite supply). Once redeemed, the fund determines the net-asset value based on when the shares were sold. The fund company must provide any monies due to the investor within seven days.
Load vs. No-Load
What’s all this talk about load, no-load, front-end load and back-end load? Load simply refers to something called 12b-1 fees or administrative fees. Front end and back end refers to when you pay those fees. A no-load mutual fund does not charge you fees to buy or redeem shares. A front-end loaded fund charges you fees to buy shares (on the front end of the transaction) but does not charge you fees to redeem shares (on the back end of the transaction). A back-end loaded fund charges you to redeem but not to buy. And some funds double-dip and are fully loaded. These funds charge both front and back-end fees.
- Jupiterimages/Photos.com/Getty Images