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Funds, funds, funds

Confused by different types of funds? Here’s a review of what’s what

Mutual Funds

With over 8,000 funds available, these investment pools are what we usually think of. Strictly speaking they are open-end mutual funds as opposed toclosed-end funds (see below) because the number of outstanding shares is not fixed. Every time an investor wants to invest money in an open-end fund the company simply issues more shares. Some of these, such as the Fidelity Magellan and Vanguard S&P 500 funds have grown to enormous size; with assets of $50 or $60 billion or more.

The price of a share of an open-end fund is calculated once a day by the fund company, after the markets have closed and is simply the total value of all of the investments divided by the number of shares outstanding. This is referred to as the Net Asset Value or NAV. Shares may only be purchased from and sold to the fund company – either directly or through a brokerage account. There is no secondary market. Note that when placing a buy order you don’t know your price until after the NAV for the day has been computed.

The ticker symbol is usually 5 letters, with the last one being “X”.

Money Market Funds

A Money Market Mutual Fund is a specific type of mutual fund that invests in short-term fixed-income securities It is very similar to a bank account except that the interest rate fluctuates daily and it’s not FDIC-insured. Most offer check­writing, though generally with a minimum of anywhere from $100 to $1000, so they can’t really replace your checking ac­count. They are a great place for an emergency fund and can usually replace savings accounts and CDs. Currently rates are around 4.5% to 5%.

Many banks offer a similar vehicle, usually referred to as a money market account. Although they are FDIC-insured, they are usually a poor choice due to substantially lower interest rates.

Exchange-Traded Funds

ETFs are the hot new fund type. Their assets have grown rapidly in the last 10 years. They trade on exchanges like stocks and the price fluctuates throughout the day based on the value of the underlying securities. Most track established indexes, either broad-based such as the S&P 500 or narrowly based such as a partic­ular industry sector. The manage­ment is thus largely passive and ETFs are known for having low expenses.

Unlike a closed-end fund, once an ETF is created no new shares are issued or existing ones re­deemed.

Closed-End Funds

Like open-end funds, closed-end funds are a pool of invest­ments that are generally actively managed. Like ETFs, they trade on ex­changes. Thus, the price will fluctuate based on investor perception of the investments they contain. These funds can and do trade at either a premium or discount to their NAV.

In recent years they have lost pop­ularity and only a few hundred exist.

Hedge Funds

These are for wealthy and exper­ienced investors only – literally. Be­cause hedge funds are not registered with the SEC they may only be offered to “accredited” investors. You must have a net worth of at least $1,000,000 or annual income over $200,000 ($300,000 jointly if married). Hedge funds employ sophisticated and com­plex trading strategies to try to eke out additional gains from small ineffi­cencies in the markets. Fees are high, typically 2% or more plus the manager usually takes a cut of the growth and earnings above a certain amount. Because of this and also the difficulty of obtaining reliable information about these funds, Mentor Capital does not recommend their use for even our wealthiest clients.