Understanding the Different Types of Funds


Many people wonder about the various funds that their brokerage offers. They don’t understand the difference between the funds. This lack of understanding makes it difficult to decide exactly which fund is the right one to match the investor’s goals.

As a result, people sometimes rely on metrics that they think they do understand. They may compare the 10-year rate of return for two funds and decide to invest in the one with the highest return, for example. This may not make sense for an investor if the two funds have very different levels of risk.

Other people compare the NAV of two funds, and just choose the one with the highest rate. Once again, this may not make sense. The two funds may have very different objectives. They may invest in different markets. One may be a hedge fund that plans to invest in volatile or exotic investments. The other may stick to OTC stocks. The result may be that one fund is a better fit than the other is.

Here is a brief run down on the various types of funds and exchanges.

Mutual Funds

You usually buy mutual funds through a brokerage. A company such as Fidelity or Vanguard manages the fund. These funds have an objective. The fund manager buys a mix of securities to try to meet the objective. Most mutual funds own more than 100 different securities. Some own thousands.

When you buy a share of a mutual fund, you do not own shares of the securities it owns. You and the other investor’s in the fund mutually own an interest in the securities that the fund buys.

Many mutual funds charge their investors service fees. There may be fees for selling your shares or for other services.

When you are deciding which mutual fund to buy, you should read the prospectus carefully. This will tell you what the fund’s objectives are. Knowing the fund’s goals will help you decide if your goals are compatible.

Next look at its return rate. You should also look at each fund’s fee structure.

Closed-end Funds

A closed-end fund is a public investment company. It uses an IPO to raise a fixed amount of capital. Once it reaches its goal, it invests the funds according to its stated objectives. Shares of closed-end funds trade in stock exchanges.

Hedge Funds

Hedge funds use a variety of sophisticated investment techniques to increase its returns. It may trade long or short. It may take derivative positions. Hedge funds may acquire highly leveraged assets. Some buy exotic assets such as art, real estate or currencies.

Hedge funds try to generate very high returns. This makes them riskier than some other investments. Hedge funds are usually only open to a limited number of partners. If you invest in a hedge fund, you may not be able to withdraw your funds for a specified period.

Exchange-Traded Funds

An exchange-traded fund is a security that trades over the counter like a stock. ETFs match their strategy to an index. The fund manager tries to beat or match the index’s return.

Commodity Funds

Commodity funds only invest in commodities. Some may specialize in a certain commodity such as precious metals. Others focus on agricultural products such as corn or soybeans. Still others invest in oil and gas.

It is not easy for an individual investor to buy commodities. Commodity funds act like a mutual fund. They allow investors to buy shares in the fund. The fund buys the commodity. This enables people interested in commodity investing to do so easily.

Currency Funds

Currency funds are a sub-type of ETFs. They may invest in one or several specified currencies. They do not invest in other types of assets. Currency funds make it easy for investors to invest in currency trading without having to deal with a forex account. This is a good option for people who are interested in currency investing but who don’t have the time or skill to stay up-to-date on the market.

Money Market Funds

Money market funds are another variation on mutual funds. Money market funds offer a very safe investment. The returns are better than savings accounts at a bank pay. Investors looking for a nearly risk-free place to keep large amounts of cash often use money market funds.

Private Equity Fund

Private equity funds pool cash from more than one investor. The fund invests this cash into startup companies. They may fund leveraged buyout or buy plants and equipment for existing companies in exchange for a share of the ownership. Private equity funds do not trade on the open market.

Private equity funds may be high risk. They also require relatively long investment periods. If you invest in a private equity fund, you may not be able to withdraw your capital until the fund meets its objective.

Unit Investment Trusts

Unit investment trusts, or UITs, have a fixed portfolio of securities and other assets. UITs do not actively manage the portfolio. Investors buy units for a certain time. They earn the return that the portfolio generates during that time.

Investors may choose a UIT to earn dividends or for the capital increase in the value of its assets.

Many of these funds are variations on the idea of a mutual fund. Investors pool their funds to buy an asset bundle for mutual ownership. This idea allows people to invest in a sector that interests them without requiring day-to-day. Funds may reduce the upfront capital needed to invest in a sector. They may also provide professional fund management that helps to reduce risk.

No matter which investment area interests you, you can find a fund that caters to it. The trick is to match your investment goals, risk tolerance and short-term need for the cash with the right fund for you.

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