Funds and how they work

The investment company that sponsors a mutual fund sells shares to investors and then invests the funds that are received in a portfolio of securities. By pooling investors’ funds, a fund manager can diversify the purchase of different securities, such as stocks for stock funds and bonds for bond funds. The objectives of a fund determine the types of investments chosen. For example, if a stock fund’s objective is to provide capital appreciation, the fund invests in growth stocks.

Dividends from stocks in the portfolio are passed through to the fund’s shareholders (as dividends from the fund). An investor who invests $1,000 gets the same rate of return as another investor who invests $100,000 in the same fund, except the latter shareholder receives a dividend that is 100 times greater (proportionate to the share ownership in the fund).

When prices of securities in the portfolio fluctuate, the total value of the fund is affected. Many different factors—such as the intrinsic risk of the types of securities in the portfolio, in addition to economic, market, and political factors—cause these price fluctuations. The fund’s objectives are important because they indicate the type and quality of the investments chosen by the fund. From these objectives, investors can better assess the overall risk the fund is willing to take to improve income (return) and capital gains. Investment companies offer four different types of funds:
* Open-end mutual funds
* Closed-end funds
* Unit investment trusts (UITs)
* Exchange-traded funds (ETFs)—ETFs are mostly sponsored by brokerage firms and banks.

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