If it has the word fund in it, the phrase must mean money, and that's true of both mutual funds and trust funds. Both have a value based on the holdings, or assets, in the portfolio, but the similarity pretty much ends there. Anybody can buy into a mutual fund, but having a trust fund means major bucks. After all, nobody's ever heard of a mutual fund baby.
While a mutual fund allows for investment in several company stocks without actually owning the stocks, a trust fund is a legal entity that addresses the distribution of assets.
What Is a Mutual Fund?
A mutual fund is invested in the stocks of several different companies based on the decisions of the fund manager. The risk is spread across the investments. If the stock of any one company doesn't perform as expected, the other companies' stock performances compensate – at least that's what the fund manager hopes.
When you buy shares in the mutual fund, that's what you own. You don't own the stock of the companies in the mutual fund portfolio.
What Is a Trust Fund?
A trust fund is a legal entity that owns assets. It is based on a legal document which outlines the beneficiary of the trust, when and if the money from the trust is distributed and what assets may be in the trust fund. The grantor provides the initial assets for the trust and establishes the rules for managing the trust through the legal document.
A trustee makes the decision of what assets to acquire, when the money gets distributed and who gets the money. Those decisions are based on the legal document.
Revocable and Nonrevocable Trust Funds
The trust fund may be revocable, which means the person, or entity, who set up the trust fund can decide it's not required anymore and distribute the assets out of the trust. Or the fund is nonrevocable, which means once it's set up, it's permanent until a certain set of circumstances are met that are described in the trust document. In other words, if the trust fund says that no money will be distributed until the beneficiary reaches the age of 35, then end of story, no matter what the circumstances, no money will be distributed. This can cause conflict if the beneficiary has his heart set on receiving a new corvette when he turns 21.
Why They Exist
Mutual funds are set up to make money for both the management company and the shareholders. That is their reason for existence.
Trust funds are set up for various reasons. The beneficiary of the fund may be too young or not financially responsible – think of a certain female hotel heiress – to handle the assets themselves. Setting up a trust avoids probate for major assets, although personal items may be included in a will.
A trust fund may keep the assets together, such as real estate holdings, for a greater value than if sold and the proceeds split among the heirs. And finally, a trust fund may keep the assets from creditors if the beneficiary is financially insolvent.
Understanding Fund Ownership
The mutual fund is owned by the company managing the fund. Shares of the fund are sold to investors – that would be you. It's similar to owning shares in a publicly-traded company, but one step removed.
A trust fund isn't owned by anyone – not even the beneficiary. It is a legal entity onto itself. Think of it as a parent figure who decides what your allowance is going to be.