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The number of funds an investment company offers varies widely, from as few as two or three to Fidelity's 140. At the time of publication, there were 338 fund groups, offering more than four thousand funds. That may seem like an overwhelming choice, but it's nothing compared with the numbers you'd face if you were choosing an individual stock.
Different funds are created to appeal to a variety of investors, both individuals and institutions, each of whom may have different objectives and approaches to investing.
In each case, the fund company follows these steps in creating a fund:
Each mutual fund must have an investment objective or goal, and a plan - sometimes called an investment program - it follows in building its portfolio. For instance, a fund that seeks growth buys shares in companies that it expects to expand and prosper in the years ahead.
Any major changes in the way a fund operates or invests its money must be approved by its shareholders.
So the more money investors put into an open-end fund, the larger it grows.
Sometimes a mutual fund company will close an open-end fund to new investors if it grows too large to be managed effectively; even then, current shareholders can continue to invest money. When a fund is closed this way, the investment company often creates a new fund with a similar portfolio to allow new investors to buy in.
Closed-end funds invest in a portfolio of securities, the same way open-end funds do, but a fund raises money only once (like the initial sale of a stock) and offers investors only a fixed number of shares. After the initial offering, shares in the fund are traded on a stock exchange. Sometimes, they're also referred to as "exchange-traded funds."
The price an investor pays for a closed-end fund fluctuates in response to investor demand as well as to changes in the value of its holdings.
A fund's buy and sell decisions are made by a professional manager who specializes in the type of investment the fund makes. In fact, the identity of the manager is often a key factor in how well a fund does--and a manager's departure may be a signal to investors that it's time to get out of the fund.
But don't expect the Beastie Boys to be endorsing mutual funds any time soon. Traditionally, mutual fund companies advertise their wares through the financial press, direct mailing, and press announcements. In some cases, they work with brokers who make commissions selling particular funds. Conscience or green funds, for example, are created to attract investors whose political views would favor environmentally friendly investments.
The fund pays out, or distributes, its profits (minus fees and expenses) to its investors.
You owe federal and sometimes state income taxes on the distributions you receive from a taxable fund, whether the money is reinvested or paid out in cash.
But if a fund loses more than it makes in any year, the losses can offset future gains. Until profits equal the accumulated losses, distributions aren't taxable, although the share price may increase to reflect the profits.
It's also because mutual funds offer the option of reinvesting all or part of your distributions to buy more shares in the fund. Then you've got a bigger investment base, which can earn bigger distributions, and so on, ever upward.
Many financial experts recommend using mutual funds as long-term investments, funneling all your earnings back into the fund.
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