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Mutual Funds Animation

BASKETS FOR YOUR INVESTMENT EGGS

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This page is intended to be a tutorial for the investor who seeks basic information about mutual funds, what they are, how they work, and how they can fit into an investment plan.

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Wait a minute. what was all that about Evening Moon? It was a play on words involving Morningstar. They are the most well-known mutual fund rating and information company on the planet and Evening Moon was another clever way for us to get you to visit one of our pages. It's possible you might pick up a tidbit or two of information here that you didn't have before. So, here we go.

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What is a mutual fund and why would you want to give them any of your money? The government calls such entities regulated investment companies and gives them special tax and other rules to follow, as we'll see later. Basically, it's a company that takes the money of lots of people, pools it all together and invests it for the "mutual" benefit of all the investors, as well as the management company that runs the fund.

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Shares of a mutual fund can be purchased or redeemed by two methods. If the fund is "open-ended", then all day, every business day, it buys and sells its shares directly between itself and the shareholders. If it is "closed-end", then after the original number of shares are sold to the public, those shares trade on the open market like any other public company and the fund company only has to invest the original pile of money it got at the initial public offering (so-called IPO)and does not redeem shares from shareholders or sell additional shares unless it uses the same method that other public companies do to sell additional shares after an IPO.

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What does this mean, then, in deciding which type to buy? The price we use to buy or sell (redeem) shares is different in each case.

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If we buy or sell the open-ended fund, the price used is called the Net Asset Value, or NAV. It is computed, usually once a day after the close of all the public security markets, by adding up the market value of all the securities in the fund's portfolio, adding to that the dividends and interest due the fund but not paid to it yet, and adding any other assets the fund owns. This total is reduced by any unpaid bills the fund has for expenses and different operating outlays. The difference of these two is called Net Assets and that is divided by the total number of shares outstanding, giving the Net Asset value per share. This number is used by the fund to fill buy orders (plus any commissions or "loads") received that business day and cut checks for people who want to redeem their shares.

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Buying or selling shares of an closed-end fund is like buying or selling shares in Coca-cola or Ford Motor or Intel, etc. We call a broker or log on our online broker and tell them we want to buy or sell the XYZ fund's shares. Usually, shares of closed-end funds sell at different prices than the NAV on a given day. If the share price is above the NAV, it's said to be selling at a premium and if less, then, at a discount. You see discounts more than premiums, which means that you are buying shares with a NAV of say $10.00 for $9.00, a discount of 10%. These differences arise for a number of reasons, some very similar to why Ford sells at a given price and Intel for another. It boils down to supply and demand. If the market likes what the fund invests in, and sees good things ahead, it may bid up prices to be near or exceed NAV. If it does not, or an investment style or sector the fund is investing in is not doing well or out of favor, the share price may decline below NAV.

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There are many more open-end funds than closed-end. Many closed-end funds are highly specialized in their investment approach. They may invest in only one country, or say, only in the municipal bonds of one state. It comes down to personal choice whether to buy such funds. You should research these companies with the same attitude you would if you were researching any publicly-traded company, such as, can it fulfill a need in my portfolio at a reasonable cost and be a realistic candidate for appreciation as time goes by?

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Buying open-ended funds requires us to ask a number of questions about the fund(s):

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Now you are ready to tackle the wonderful world of mutual funds. Don't forget to check our links page for fund company home pages to visit.

Rainbow

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