How Do Investment Funds Work?

An investment fund is a cooperative effort between investors with a common goal. Investors pool their savings to purchase larger investments than any one individual would be able to purchase on his own. Working as a group also reduces each individual’s risk and avoids high trading costs, as the fund spreads fee liability across all investors.

When properly managed, investment funds may provide a safe, consistent rate of return. The Investment Company Act of 1940 along with the Securities Act of 1933 and the Securities Exchange Act of 1934 govern all investment fund rules and regulations, helping protect investors from potential fraud.

Investment Fund Function

Each investor buys into the investment fund by purchasing fund units, the price of which will vary depending on the fund’s investment goals. The number of fund units owned will determine each investor’s share of the fund’s profits. A designated fund manager oversees the investment fund’s operation, investing the collected money into securities determined by the fund’s agreed upon rules and objectives.

Types of Investment Funds

Investment funds typically invest in equity funds, fixed-income funds or money market funds. Equity funds, or investments in stocks, target long-term capital growth. Fixed-income funds, also known as bond funds, attempt to generate steady income for the investors, generally profiting from corporate and government debt. Finally, money market funds provide the least risk, investing in Treasury bills that return a modest but dependable rate of return.

Investors may also classify investment funds according to the types of investments made, such as technology or real estate.

Open-Ended Mutual Fund

Investment funds may also be either open or closed. An open-ended investment fund is known as a mutual fund. Since they’re open-ended, mutual funds may sell any number of shares at any time in order to increase the investment fund’s capital base. Shareholders may join or leave an open-ended fund at any time, cashing out their shares for the amount of the fund’s overall net assets divided by outstanding shares.

Close-Ended Investment Trust

A closed-ended investment fund, investment trusts issue a fixed number of shares. Once all its shares have been purchased, an investment trust refuses any additional investors as opposed to simply issuing more shares like an open-ended fun.

To enter into an existing investment trust, new investors must purchase shares from shareholders. Conversely, if shareholders wish to exit the investment trust, they must find someone to purchase their shares; they can’t simply redeem them from the trust. Investment trusts may also impose additional fees and expenses over other types of investment funds.

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