What is a mutual fund, and why are they so popular? Simply put, a mutual fund is a company that invests in other companies.
By selling its shares to the public and investing the proceeds in securities of other companies, a mutual fund makes it possible for the small investor to own a diverse portfolio of stock in a market once dominated by the big investor.
The security and liquidity of mutual funds, and the relatively low cost of having someone else make knowledgeable investment decisions for you, have made them exceedingly popular.
Mutual funds can be of two types - open-end or closed-end (see previous page) - and have a range of ``costs.''
Because some of these costs are buried deep within the prospectus, it is important for investors to be aware of the total fees attached before buying shares of a mutual fund company.
Load. A sales commission paid to in-house salesmen, brokers, financial planners or money managers when shares are sold. On a fully-loaded fund, this is 8 percent of the money you invest.
Low-load. A smaller sales charge, often paid to the fund itself, rather than to salesmen or brokers, to cover administration and marketing. Most low-load funds charge 2 or 3 percent.
No-load. No sales or marketing charge. A true no-load fund charges no fee at sales or redemption. All funds, however, including no-loads, take out 1 to 1 percent of the assets each year as a management fee. This pays for the salaries of portfolio managers, offices, equipment, and clerical help.
Back-end loads. This is another form of sales charge. The salesman is still paid at the beginning of the investment, but the investor isn't charged until money is taken out. Back-end fees are often on a sliding scale, with 5 percent charged the first year, 4 percent the second year, and so on, until there is no back-end charge after five years.
12b-1 plans. These plans, named for a section of the Securities and Exchange Commission ruling that allowed them, let a fund use a small percentage of assets to meet advertising and marketing costs. Some funds simply say they have a 12b-1 without saying how much it will be; others have a range of possible charges.