Chapter 2-1 Introduction to Funds

Mutual funds are a common method for investing in stocks.  They provide particular benefits over buying individual stocks and bonds because mutual funds can give you included variety and professional management.  However, similar to investing in any stock, investing in a mutual fund includes particular risks, along with the likelihood that you may lose money.

A mutual fund, known as an open-end company, is an investment company that combines money from a number of investors and invests it depending on particular investment objectives.  The mutual fund acquires money by selling its own shares to investors.  The money is spent to buy a portfolio of stocks, bonds, short-term money-market instruments, other securities or assets, or any combination of these investments.  Every share portrays an ownership portion of the fund and gives the investor an equivalent privilege, depending on the amount of shares he or she owns, to income and capital gains that the fund makes from its investments.

The specific investments a fund executes are based on its goals and, in the case of an actively managed fund, by the investment technique and experience of the fund’s professional manager or managers.  The assets of the mutual fund are recognized as its fundamental investments, and the performance of those investments, less the fund fees, decide the fund’s investment return.

Even though there are thousands of particular mutual funds, there are only a few main fund classifications.  The first classification is a stock fund, which invests in stocks.  The second type is a bond fund.  A bond fund invests in bonds.  A balanced fund, which is another type, invests in a blend of stocks and bonds.  The fourth fund classification is a money market fund, which invests in very short-term investments.  They are at times referred to as cash equivalents.  The majority of fund companies also provide one or more money market funds.

You can locate all of the particulars about a mutual fund, including its investment approach, risk outline, historical performance records, management, and fees, in a report named the prospectus.  You should always read the prospectus prior to investing in a fund.

Mutual funds are equity investments, as individual stocks are.  When you purchase shares of a fund you assume the role of part owner of the fund.  This is valid for both bond funds and stock funds, which signifies there is a significant difference between owning a single bond and owning a fund that holds that same bond.  When you purchase a bond, you are guaranteed a particular rate of interest and return of your money.  In contrast a bond fund holds a quantity of bonds with varying rates and maturities.  Your money invested possession of the fund gives you the privilege to a portion of what the fund accumulates in interest, earns in capital gains, and gets back if it holds a bond to maturity.

If you own shares in a mutual fund you partake in its gains.  For instance, when the fund’s intrinsic stocks or bonds yield income from dividends or interest, the fund gives those profits, after costs, to its shareholders in payments referred to as income distributions.  When the fund has capital gains from selling assets in its portfolio for a gain, it gives those profits, after costs, to shareholders as capital gains distributions.  You typically have the alternative of being given these distributions in cash or having them automatically reinvested in the fund to raise the number of shares you own.

However, you will owe taxes on the fund’s income distributions, and typically on its capital gains, if you hold the fund in a taxable account.  You may have short-term capital gains when you invest in a mutual fund.  Short-term capital gains are levied at the equivalent rate of your regular income.  This is something you may attempt to steer clear of when you sell your individual securities.  You may also have to pay capital gains taxes if the fund sells some assets for more than they purchased them for, and it does not matter if the comprehensive return on the fund is lower for the year or if you became a shareholder of the fund after the fund purchased those assets under consideration.  But if you hold the mutual fund in a tax-deferred or tax-free account, like an IRA, no tax is owed on any of these allocations when you get them.  However, you will have to pay tax at your normal rate on any withdrawal from a tax-deferred account.

You may also get money from your fund shares by selling them back to the fund, or cashing them in, if the intrinsic investments in the fund have gone up in value from the time that you bought shares in the funds.  If this situation occurs, your profit will be the growth in the fund’s per-share price, also referred to as its net asset value (NAV).  Taxes here are also owed the year that you earn gains in a taxable account, but not in a tax-deferred or tax-free account.  Capital gains for mutual funds are measured to some extent in a different manner than earnings for individual investments, and the fund will inform you every year your taxable portion of the fund’s profits.

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