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The Big 3 Types of Funds: Mutual, ETF, Closed-End… The Necessary Explanations

Below you will find links to Investopedia’s dry, long-winded explanations as well as ours, which will give you a good enough understanding that articles make sense. Use the links or google if you still have questions. And yes, some of the definitions are repeated on purpose.

 

Learn these words first:

Fund
Buying a stock is  buying a share (or portion) of a company, but only that one company. A fund is more like a basket that can hold lots of different stocks or investments. So instead buying a portion of one thing, you can buy a portion of lots of things at once. Investors in a fund are buying a share of the basket.

Active
There’s somebody actively making decisions on what to buy and sell in a fund.

Passive
Nobody is making decisions, the fund tries to follow an index as closely as possible.

Index
A number that is follows how well or poorly things are doing compared to history. For instance, the Dow Jones takes 30 big companies in the US, adds their stock share prices together and based on the result people can gauge how the stock market is doing. Indexes (or indices) usually follow different markets based on things like size of companies, geography, how they grow, etc. People who want to just “buy an entire stock market” like the US stock market can then just buy a US stock market index.

Net Asset Value
The value of all the things in the fund or “basket” added together.

 

The Fund Types:

Mutual Fund
An investment product that pools money together in a basket to invest in stocks, bonds, real estate, etc. Mutual funds will have a stated objective to decide on what it will buy. They can be active (with a manager choosing  what to buy or sell) or passive (just following an index without making decisions) They can create as many shares as they want for investors to buy into this basket or “pool of money”.  The price of the fund’s shares are calculated after the markets close and the value of all things owned by the fund (Net Asset Value) are divided by the number of shares available. Mutual funds only trade once a day, after market close. Taxation on mutual funds is different than other types of funds. Typically carry a lot of hidden fees that are disclosed in small print. Usually the only type of fund available in a 401k. Mutual funds are largely outdated and individual investors nearly always prefer ETFs.

ETF (Exchange-Traded Fund)
Nearly everything is the same as mutual fund as far as active/passive investments, but these can trade any time the markets are open, just like stocks. Fees and expenses are usually much less than mutual funds. Taxation of the fund depends largely on what the fund does. Like mutual funds, can create or destroy the number of shares available in order to fit with objective of the fund. SPY (that’s the symbol, but is said just like the word) is the most commonly traded ETF in the world, it follows the S&P 500 index.

Closed-End Fund
Almost exactly like ETFs, but only have a finite (limited) number of shares. Because of the limited number of shares, a great opportunity can arise: if there isn’t much demand for the fund’s shares, but the value of assets (NAV) held by the fund haven’t dropped, investors can essentially buy the stocks or assets at a discount. Most commonly used by investors looking for income.

 

Other helpful links:

Active vs Passive Investing

Mutual Fund vs ETF: Which is Right For You?

Closed-End vs. Open-End Funds