The Different Types of Funds
Two basic types of funds are open-end or closed-end funds. Open-end
funds issue unlimited numbers of shares. Investors can purchase
more shares from the mutual fund company and sell them back to
the fund company, which means that the number of shares increases
or decreases, respectively. A closed-end fund issues a fixed number of
shares, and when all the shares are sold, no more are issued. In other
words, closed-end funds have fixed capital structures.
Shares are bought in an open-end mutual fund at its net asset
value. Net asset value (NAV) is the market value of the fund’s assets
at the end of each trading day minus any liabilities divided by the
number of outstanding shares.
Open-end funds determine the market value of their assets at
the end of each trading day. For example, a balanced fund, which
invests in both common stocks and bonds, uses the closing prices
of the stock and bond holdings for the day to determine market
value. The number of shares of each of the stocks and the number
of bonds that the fund owns are multiplied by the closing prices.
The resulting totals of each investment are added together, and any
liabilities associated with the fund (such as accrued expenses) are
subtracted. The resulting total net assets are divided by the number
of shares outstanding in the fund to equal the NAV price per
share. Table 14–1 shows how the NAV is determined.
The NAV changes daily because of market fluctuations of the
stock and bond prices in the fund. NAVs are important because
1. The NAV is used to determine the value of your holdings
in the mutual fund (the number of shares held multiplied
by the NAV price per share).
2. The NAV is the price at which new shares are purchased or
NAVs of the different funds are quoted in daily newspapers or on
the fund’s Web site. Mutual funds pay no taxes on income derived from their
investments. Under the Internal Revenue Service Tax Code, mutual
funds serve as conduits through which income from investments is
passed to shareholders in the form of dividends and capital gains
or losses. Individual investors pay taxes on income and capital
gains distributions from mutual funds.
Shareholders receive monthly and annual statements showing
purchases and sales of shares, interest income, dividends, capital
gains and losses, and other relevant data that they should retain
for tax purposes. In addition, when investing in mutual funds,
investors also should keep track of the NAV prices of shares purchased
and sold. This information is used in the computation of
gains and losses when shares are redeemed.
How the Net Asset Value (NAV) of a Fund Is Determined
The value of a mutual fund increases when
* Interest and dividends earned on the fund’s investments
are passed through to shareholders.
* The fund’s management sells investment securities at a
profit. The capital gains from the sale are passed through to
shareholders. If securities are sold at a loss, the capital loss
is offset against the gains of the fund, and the net gain or
loss is passed through to shareholders.
* The NAV per share increases.
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Using too much Leverage
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Failure to control Risk
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Useful Advices to Beginning Trader
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