The Different Types of Funds

Two basic types of funds are open-end or closed-end funds. Open-end funds issue unlimited numbers of shares. Investors can purchase more shares from the mutual fund company and sell them back to the fund company, which means that the number of shares increases or decreases, respectively. A closed-end fund issues a fixed number of shares, and when all the shares are sold, no more are issued. In other words, closed-end funds have fixed capital structures. Shares are bought in an open-end mutual fund at its net asset value. Net asset value (NAV) is the market value of the fund’s assets at the end of each trading day minus any liabilities divided by the number of outstanding shares.

Open-end funds determine the market value of their assets at the end of each trading day. For example, a balanced fund, which invests in both common stocks and bonds, uses the closing prices of the stock and bond holdings for the day to determine market value. The number of shares of each of the stocks and the number of bonds that the fund owns are multiplied by the closing prices. The resulting totals of each investment are added together, and any liabilities associated with the fund (such as accrued expenses) are subtracted. The resulting total net assets are divided by the number of shares outstanding in the fund to equal the NAV price per share. Table 14–1 shows how the NAV is determined.

The NAV changes daily because of market fluctuations of the stock and bond prices in the fund. NAVs are important because
1. The NAV is used to determine the value of your holdings in the mutual fund (the number of shares held multiplied by the NAV price per share).
2. The NAV is the price at which new shares are purchased or redeemed.

NAVs of the different funds are quoted in daily newspapers or on the fund’s Web site. Mutual funds pay no taxes on income derived from their investments. Under the Internal Revenue Service Tax Code, mutual funds serve as conduits through which income from investments is passed to shareholders in the form of dividends and capital gains or losses. Individual investors pay taxes on income and capital gains distributions from mutual funds.

Shareholders receive monthly and annual statements showing purchases and sales of shares, interest income, dividends, capital gains and losses, and other relevant data that they should retain for tax purposes. In addition, when investing in mutual funds, investors also should keep track of the NAV prices of shares purchased and sold. This information is used in the computation of gains and losses when shares are redeemed.

Table 14-1
How the Net Asset Value (NAV) of a Fund Is Determined


The value of a mutual fund increases when
* Interest and dividends earned on the fund’s investments are passed through to shareholders.
* The fund’s management sells investment securities at a profit. The capital gains from the sale are passed through to shareholders. If securities are sold at a loss, the capital loss is offset against the gains of the fund, and the net gain or loss is passed through to shareholders.
* The NAV per share increases.

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