Mutual Funds & Other Pooled Investment Funds
Investing in a pooled fund can provide a convenient way to co-own valuable resources. Investors can select a pooled fund which specializes in the resource of their preference: stocks, bonds, commodities, currencies, etc. Co-owning resources in a pooled fund can have various advantages over owning the same resources individually. Pooled funds offer the benefit of a fund manager or team of managers who guide the fund wisely. Most funds offer a performance-based fee for managers, and so the managers have an interest in seeing the fund succeed. Significantly, the primary quality of fund managers is investment expertise. As most investors are novices when it comes to selecting and managing the right resources, this is a very attractive quality. Pooled funds therefore allow investors to capitalize on the financial expertise of another party for a small fee.
In this post, we will identify and discuss several of the more common types of pooled funds. We will then give brief descriptions of each fund, and discuss how each fund differs from others. Investors should have a clear understanding of the unique traits of a fund before making an investment decision. Certain funds, such as hedge funds, may be able to generate greater short-term returns, but may also be riskier. Investors should come away from this post with the basic tools to differentiate between the various pooled funds.
Mutual funds are perhaps the most common type of pooled fund available to investors. These funds provide an avenue for smaller investors to co-own a diversified investment portfolio. Often, they are independent companies, and individual investors buy shares in the company. Investors then take part in the aggregate performance of the fund in accordance with their ownership percentage. Like hedge funds, mutual funds can specialize in any type of security or commodity. Most mutual funds invest in hundreds of different stocks or bonds. The aim of this practice is to develop a sufficient level of diversification in order to avoid excessive risk. The majority of mutual funds, therefore, are relatively low risk investment vehicles.
Fund managers run mutual funds. Their goal is to run the fund in the best interests of the investors. Most mutual funds will have very few employees beyond the central manager. Occasionally, funds will employ analysts or researchers to help select stocks or other securities. Again, the key strategy of most mutual funds is diversification. Mutual funds tend to invest less in analysis and research because their underlying strategy is to invest in a high number of assets. This means that they can be less certain about any individual asset’s performance.
Mutual funds come in different varieties. Some mutual funds only invest in a specific type of asset, such as government bonds. In the future, we will discuss these different mutual fund varieties in greater detail.
Money Market Funds
A subset of mutual funds, money market funds are pooled investment vehicles specializing in low risk securities. Money market funds are actually restricted to low risk securities. Accordingly, they are a predictable investment vehicle. Specifically, money market funds concentrate their investment in government treasuries and other low risk instruments. Because money market funds are not as volatile as other mutual funds, the managers of these funds tend to receive lower fees. This makes intuitive sense, because managerial fees are typically based on fund performance. Money market fund managers can expect relatively low, but highly predictable, fund fees. Money market funds often have specific uses. For instance, these funds are often a destination for proceeds from the sales of other securities.
Open only to “accredited investors,” hedge funds are specialized funds which have high minimum investment requirements. Hedge fund managers typically operate on a dual compensation schedule. Managers are paid a fixed fee based on investment amount, and a performance fee based on overall returns. Hedge funds can specialize in any commodity and can operate using any investment strategy. And, because these funds are subject to few regulations, hedge funds can utilize high risk investment techniques. Accredited investors who choose to invest in a hedge fund may be fortunate and receive great returns. But, the opposite may also happen: investors may end up losing a large chunk of their investment should the fund perform poorly.
An exchange-traded fund, or ETF, is a fund that trades on the stock market. ETFs are therefore very similar to other companies traded on stock markets. Investors may buy shares in ETFs and also sell those shares just as they would with a traditional publicly-traded company. ETFs are preferable to many investors because they combine elements of both standard mutual funds and stocks. ETFs offer diversification, tax efficiency, reasonable managerial fees, and also the ability to sell and buy freely. The primary market for ETFs is between ETF distributors and “authorized participants.” On this market, ETF shares are typically bought and sold in large bundles of thousands of shares. The secondary market for ETFs is between ETF retail dealers and individual investors. The vast majority of ETFs track a particular index, such as a stock index, and follow this index in order to optimize their portfolio.
And there you have it. These are a few of the more common pooled funds available to investors. Each of these funds may be optimal depending on the given situation. No matter which fund an investor selects, however, all profits will be subject to tax.
New York City Tax Attorneys
It’s not uncommon for investors to be overwhelmed with taxes once they invest in a fund. This is why it’s particularly important to hire competent help. The professionals at Mackay, Caswell & Callahan, P.C., have a great deal of experience handling tax matters, including back tax debt. If your investments have led to back tax issues, you should reach out to one of our experienced tax professionals. Contact one of our top New York City tax attorneys and we will review your case immediately.
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