Joseph A Leonard - Wealth Management & Consulting

Mutual funds are professionally managed, which makes them preferable to managing your own investments. These funds pool money from investors, usually a very large number of investors, and then invest it in stocks, bonds, money-market instruments, or securities of some kind or other. The mutual funds manager is the one who does the trading. Proceeds or losses are usually distributed to investors annually.

Mutual funds are a wise way to go in most investment situations. One advantage is that the costs are borne by all the shareholders. This makes cost-effective diversification possible. Also, a professional fund manager will use his/her expertise and dedicated time to do the research and make management decisions. Even so, a mutual fund that invests in stocks will be subject to the same ups and downs as the stock market.

You may be able to choose from several classes of shares in any mutual fund. The major difference is in the services the shareholder enjoys and the distribution arrangements that entail a range of fees and expenses. The differences are generally presented as the different costs involved in the various classes. If the shares are sold through brokers with a front-end load, the costs will reflect that. On the other hand, if the shares that are sold directly to the public with no load, the costs will also reflect that. It’s even likely that one class will be $10-million-minimum investors, generally only financial institutions. For all of these reasons, various classes will perform differently.

Front-end load or sales charge means the commission a broker will charge at the time that the mutual fund purchases shares. However, some funds have a back-end load, which means the sales charge is deferred. In other words, the investor pays no charge up front but will pay the charge out of proceeds when the shares are sold. A level-load fund is one whose sales charge is due if the shares are sold within a year of purchase.

Bond Funds

Eighteen percent of mutual fund assets are bond funds, including term funds (fixed time before they mature). Municipal bond funds tend to have lower returns; however, the tax advantages are significant and there is lower risk with these funds. At greater risk are high-yield bond funds. These are corporate bonds and will include high-yield or junk bonds.

Money-Market Funds

Twenty-six percent of mutual funds are in money markets. These carry the least risk, but the rate of return is lower. Money-market shares can be redeemed at any time; they are different from CDs in this.

Funds of Funds

It’s not uncommon for a mutual fund to invest in other mutual funds. In other words, these are funds made up of underlying funds. Actually, the investor could invest in these underlying funds if he so chose. The fees in these funds of funds are lower and the fees charged by the underlying funds are only disclosed in the fund’s annual report or prospectus. Both fund expenses and the underlying fund expenses impact the return, so this is important information.

A variation is a fund of funds is one that invests in another fund with the same manager, called an affiliated fund. The costs are typically lower when this is the case.

Hedge Funds

These are pooled mutual funds that have little regulation by the SEC. The adviser doesn’t have to follow or avoid any investment strategies. Also, no requirements are made regarding which investments may be purchased. These funds usually charge a management fee of 1% or more. Also, a performance fee of 20% of the fund’s profits is usually charged. Some hedge funds declare a period during which shares cannot be cashed in.

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