Investment companies come in different forms to lure investors into investing in them, no matter what they’re looking for. However, although they may look like they have everything that an investor need, from investing to making profits, etc, they aren’t one-size-fits-all.
An investment company is designed to help investors invest their hard-earned money to provide financial securities, which can be in the form of stocks, bonds, or other types of an asset class. Most investment companies are either closed-end or open-end funds, which are commonly known as mutual funds.
However, as we all know it, investing comes with risks – primarily that these investment companies invest money for shareholders. So, these investment companies have financial regulations to protect investors from fraud and infringement
Investors should be aware of the Investment Company Act of 1940, which holds the rules on how an investment company should invest its capital and how it should be managed. These companies must be registered under the Securities Exchange Commission (SEC) and have to be fully transparent to regulators to ensure the investors’ protection.
As there are different kinds of investment companies, there are various forms that every investor needs to know.
1. Mutual Funds (Open-End)
You probably heard mutual funds often as this is the most common form of an investment company. If you have 401(k), you may already have invested in a mutual fund. But did you know how it works?
A mutual fund is an investment vehicle that takes a pool of money from investors. These funds will be used to invest in securities, like stocks or bonds. Professional money managers handle investments and decide what securities to buy and sell. They are also the ones who make changes to allocations, depending on economic and financial analysis.
A mutual fund’s description shows its goals for its investors. Hence, money managers have to follow to invest their clients’ money according to the fund’s stated purpose, although they can make some changes to the fund’s holdings.
2. Mutual Fund (Closed-End)
A closed-end mutual fund is quite similar to the open-end one, but it has some key differences. As the open-end mutual fund trades once per day, the closed-end fund trades like stocks that can be bought and sold throughout the trading day.
This type of fund also issues a single IPO to raise capital and obtain a secured number of shares. Open-end mutual fund, on the other hand, regularly takes in new investors and has to change share counts.
However, both funds have active management, but the closed-end fund is stricter with how it runs. Usually, this type of fund is designed for a single purpose and doesn’t go off-track like an open-end mutual fund. Funds that are invested in specific assets, like municipals or sectors such as utilities, are usually for closed-end up funds.
3. Unit Investment Trust (UIT)
Unlike mutual funds, unit investment trust (UIT) is an investment company that offers investors a fixed portfolio of stocks and bonds. Investors who want to have a long-term investment may choose UIT.
Here, investors can earn interest from dividends and bonds, but it will only make a profit from the capital appreciation if the UITs holdings have fully matured.
Exchange-Traded Fund (ETF)
The exchange-traded fund (ETF) is a new type of investment product that is now popular with investors. It is also classified as an investment company just like mutual funds and UITs.
This type of investment comes with active or passive management that has the similar open-end fund setup. In ETF, the shares can be traded like stocks on the open market and have lower fees compared to mutual funds and UITs. Here, the Vanguard Total Bond Market ETF (BND) is cheaper than the Fidelity Total Bond Fund (FTBFX), which is basically a same-structured mutual fund.
However, investors who like to try ETF should be mindful of their choice, as they have to make sure that this will match their investment goals. If an investor wants active management, he/she may choose a mutual fund instead of an ETF that doesn’t enclose its portfolio or prevent investors from economic downturns.
Investment companies come useful for investors who want to start investing, but don’t have the time or knowledge to do it themselves. Mutual funds and UITs both have an active management team that will help investors to hedge the portfolio against economic downturns and stay diversified.
ETF is also a great way to show diversity in an investor’s portfolio. However, an investor should have to make sure that he/she will never mistake it for investment companies that are in the mutual funds and UITs category. Anyhow, these four investment companies are a great addition to every investor’s portfolio.
Photo Sources: Admiral Markets, CFA Institute, Australia News Today