What is the Definition of a Mutual Fund and Money Market Fund

Since 1940, there have been three basic types of investment companies in the United States. They are open-ends, also known as mutual funds, unit investment trusts (UITs), and closed-end funds. Mutual Funds A mutual fund is a professionally managed firm of collective investments that collects money from investors and puts it in stocks, bonds, short-term money market instruments and other securities.

A mutual fund allows a group of investors to pool their money together for a predetermined investment objective. When you invest in a mutual fund, you become a shareholder of the mutual fund.

The majority of mutual funds invest in stocks and/or bonds. Bonds are money lent to the government or a company that pays back principle and interest over a set time period. Pooling the money together reduces trading costs and adds the advantage of diversification.

A mutual fund is an open-end investment company. Mutual fund prices are set once daily at 4:00 p.m. Then the fund issues new shares to investors and buys back shares from investors that leave the fund. They do not issue undivided interests in specified securities, and they issue redeemable securities.

Equity funds, which consist mainly of stock investments, are the most common type of mutual fund. Equity funds hold 50% of all amounts invested in mutual funds in the U.S. They often focus on particular strategies.

According to The Motley Fool, “the vast majority of mutual funds underperform the average return of the stock market.” They go on to say that the best mutual funds are passively managed funds that track indexes. Index funds have lower expenses and more tax advantages.

UIT - Unit Investment Trusts and Closed-End Funds

Issue undivided interests in specified securities. Registered investment companies that are not UITs or open-end investment companies are closed-end funds.

ETF - Exchange-traded Funds

The ETF is often structured as an open-end investment company. ETFs combine characteristics of both mutual funds and closed-end funds. ETFs are traded throughout the day in the stock market, just like closed-end funds. Most ETFs are index funds and track stock market indexes. Shares are issued or redeemed by institutional investors in large blocks. Because these are normally in kind transactions, ETFs are more efficient than traditional mutual funds and tend to have lower expenses.

ETFs are more available to foreign investors who for regulatory reasons are limited in their ability to participate in traditional U.S. mutual funds.

Growth vs. Value

Growth funds are invested in stocks of companies that have the potential for large capital gains. but they usually don’t pay dividends. Value funds concentrate on stocks that are undervalued. Value stocks have historically produced higher returns, but have greater risk. Income funds tend to be more conservative investments, with a focus on stocks that pay dividends. A balanced fund may use a combination of strategies, including bonds.

Money Market Funds

Money market funds hold 26% of mutual fund assets in the United States. Money market funds have the least risk of the funds listed in this article. Therefore, they also have lower rates of return. Unlike certificates of deposit (CDs), money market shares are liquid and redeemable at any time.

Unlike bank accounts, money market funds aren’t insured by the federal government. The only failure that I have found a record of occurred in 1994, but the owner’s of the money markets were paid 96 cents per dollar.

Money market funds were invented 37 years ago to offer investors better returns than bank savings accounts while providing a high degree of safety. Most of the $2.5 trillion sitting in these funds is invested in such assets as U.S. Treasury bills, certificates of deposit and short-term commercial debt.

Unbeknownst to most investors, some of the largest money market funds today are putting part of their cash into one of the riskiest debt investments in the world: collateralized debt obligations (CDOs) backed by subprime mortgage loans. CDOs are packages of bonds and loans, and almost half of all CDOs sold in the U.S. in 2006 contained subprime debt, according to a March report by Moody’s
Investors Service.

Vanguard Group Inc., the second-largest mutual fund company in the U.S., has a policy of never buying CDO commercial paper for its $90 billion in money market funds or $325 billion in fixed- income mutual funds. Neither does Bank of New York Mellon Corp.

This graph is from June 2007, so I’m sure these percentages have changed since then.

People use a money market both to hold savings and serve as an account to buy securities and place the proceeds of sales. Bruce Bent, who in 1970 created the first money market fund, The Reserve Fund, says no money market fund should invest in subprime debt.

SEC Rule 2A-7 “The money market fund shall limit its portfolio investments to … securities that the fund’s board of directors determines present minimal credit risks.” Despite this, some have invested in subprime debt.

In Summary

How to invest your money all comes down to how much risk you want to tolerate. You should always have a balanced portfolio with some money in low risk investments and some in medium to high risk investments, depending on how much you have to invest and your risk tolerance.