are registered investment companies that pool investors capital for the purpose of investing in securities.Mutual funds are managed by professional money managers. They are a primary funding vehicle for the corporate contributory retirement system in the United States. As of 2017, a total of 9,356 U.S. mutual funds held over 18 trillion dollars of assets, owned by forty-five percent of American households and an estimated 101.9 million individuals

Mutual funds offer investors the advantage of diversification, professional management, liquidity, and convenience. These advantages are offset by such factors as costs, fund turnover, and the consequences of organizational structure. Mutual funds are distributed to investors throughbrokerswith commissions, or through firms that sell directly to investors without commissions. Funds are also differentiated by being actively managed or by passive indexing. Funds provide access tomoney markets,domestic and international bonds, anddomestic and international stocks.

Mutual funds have a number of compelling advantages.

: The first principle of mutual fund investing is broad diversification of securities. Diversification greatly reduces and can even eliminate the specific risk that comes with the ownership of just a few individual stocks and bonds. Until the advent of mutual funds it was impossible for ordinary investors to own enough securities to minimize non-market risk. Now, even a beginning investor with $1,000 can invest in a mutual fund holding thousands of individual securities so that the decline or bankruptcy of a single security will have almost no influence on the portfolio.

: Managing and holding an investment portfolio entails selecting and supervising the funds holdings. Managers must do so based on the funds objectives and policies. Managers of index funds attempt to mimic their benchmark index. Index fund managers make no attempt to select winning securities. Managers of managed funds attempt to add value by selecting securities they think will attain above-average performance within the funds objectives.

: Many securities (hedge funds, limited partnerships, real estate, CDs, etc.) cannot be sold quickly and without penalty. However, most mutual fund shares may be acquired or liquidated at a moments notice at the funds next determinednet asset valueper share. Also, mutual funds can easily be converted into cash at a fraction of the cost (a few funds have redemption fees) that would be incurred when selling individual stocks or bonds. This is also true when exchanging mutual funds.

: Mutual Fund prices and performance are readily available in newspapers, magazines, internet and research organizations such as Morningstar. Purchases can be made through brokers or directly with fund companies. Mutual fund companies provide automatic reinvestment of dividends and capital gains distributions, tax reporting, programs for regular additional investments and for systematic withdrawals, check writing on money market funds, telephone exchanges among different funds within the same family, and on-line account management .

: Swensen says individuals should invest in nonprofit funds that track market segments, such as the S&P 500. There are a range of index funds that track the U.S. domestic stock market, international markets, emerging markets and the real-estate market. Swensen says mutual funds that are organized on a not-for-profit basis dont have the same conflict of interest as for-profit funds, and they charge lower fees. The fees are even lower with nonprofit index funds, because youre not paying money managers to research stocks and buy and sell them. The fund simply holds all the stocks listed in that index. And because well-structured index funds have low churn (turnover), they are remarkably tax efficient.

According to critics, the advantages that mutual funds may bring to investors are often largely negated by high costs and conflicts of interest between the managers of the funds and the investor fund shareholder.

decry the costs of mutual fund investing. According to the Investment Company Institute

, the averageexpense ratiofor US stock mutual funds in 2014 was 1.33% (weighted average 0.70%), while the average expense ratio for US bond mutual funds was 0.98% (weighted average 0.57%).

According to Bogle, while mutual fund assets rose 1,600-fold from 1950-2004, mutual fund expenses rose 2,400 fold.

These costs directly reduce investor returns. The expense ratio does not include sales loads or fundtransaction costs.

: Bogle points out that from 1945 to 1965, stock mutual funds maintained an average turnover

of 17 percent (an average holding period of six years). Since 1965, turnover has increased to a present day average of 100 percent (average holding period of one year).

Increased turnover to such levels leads not only to greater frictional transaction costs for a fund, but also increases the likelihood of realized taxable gains.

: Thebasic structureof the mutual fund, in which an external management company owns the mutual fund is, according to critics, inherently riddled with conflicts of interest. The external management companys profits to its shareholders must come from mutual fund shareholders. In 2006, the top 30 mutual fund management companies had a corporate structure breakdown that consisted of 19 large conglomerates; 7 publicly owned firms; and 4 privately held firms. In addition, fund acquisitions and mergers have produced little realized value for fund shareholders. Luo and Qiao (2013) find that acquiring families keep most of the acquired funds intact, and merge a small fraction of the acquired funds with a few of their incumbent funds. Most involved funds, including the acquired funds and the incumbent funds that remain intact, have a performance deterioration. There is little evidence that fund expenses decrease or fund liquidity increases.

Mutual Fund Corporate Structure and Performance

Average Relative Performance (10 year returns)

Mutual funds provide access to diversified portfolios of the major asset classes:money markets,bonds, andstocks, as well as providing access to discrete market segments of each market. Funds may be actively managed, where the investment manager attempts to outperform a benchmark index, or indexed, where the investment manager attempts to match a benchmark index return. Mutual funds can be sold with or without a sales commission.

Mutual funds sold by full service brokerages, banks, and commissioned advisors usually impose a sales charge on investors known as a sales load. The sales load may be paid upfront upon purchase, or deferred until an investor redeems fund shares; this deferred charge is often called a contingent deferred sales charge (CDSC). These sales charges are in addition to a funds expense ratio and any other transaction charges a fund may impose. Sales charges are usually labeled as different share classes of a fund, as follows:

: A-shares impose a front end charge on initial investment. A fund issuing a-shares might impose a 5% load upon purchase; thus an investor committing a $10,000 investment to the fund would actually invest $9,500 in the fund with $500 going to the sales agent as a commissioned load. A-shares may also assess an additional 0.25% annual charge (known as a 12b-1 fee).

: B-shares do not charge an upfront load. Instead the shares impose a back end redemption fee combined with a 1% annual charge (12b-1 fee).The redemption fee usually declines each year until it eventually reaches zero. The combination of the annual charge and the redemption fee assures that the full load is eventually paid. The exact rate at which these fees will decline will be disclosed in the funds prospectus. Ordinarily, b-shares convert to a-shares (and reduced 12b-1 charges) once the CDSC reaches zero.

: C-shares do not charge an upfront load. C-shares are sold with a 1% CDSC for the first year, plus a 1% 12b-1 fee. The redemption fee is eliminated during year two. Unlike b-shares, c-shares never convert to a-shares; the investor pays the added 1% 12b-1 fee for as long as the fund is held.

A no-load mutual fund distributes its fund shares directly with an investor. Thus a no-load mutual fund does not employ the sales charge fees that load funds impose on shareholders. This is a distinct advantage for the do it yourself investor.

However a no-load fund may impose the following fees in addition to the expense ratio that all funds incur:

: Mutual funds incur costs buying and selling securities for the fund (

). Some funds cover the costs associated with an individual investors transactions by imposingpurchase feesandredemption feesdirectly on the investor at the time of the transactions to cover these costs. Unlike sales charges, these fees are usually paid back into the fund. A redemption fee may also be imposed as a means to deter short term market timing selling of a fund.

: Some funds may charge a separate maintenance fee for low balance fund accounts.

: A no-load fund is permitted to charge a maximum 0.25% 12b-1 fee and still remain classified as a no-load fund. The main reason that a fund might impose a 0.25% is for purchasing access to a brokerage firms fund supermarket. The fee allows the brokerage to offer the fund as a No Transaction Fee fund in the supermarket.

Money funds are regulated underRule 2a-7of the 1940 Investment Company Act. Key provisions of the regulations require the following:

: Money funds can only invest in money market instruments maturing under 12 months and must maintain a weighted average maturity of 60 days or less.

: With the exception of federal government securities, money funds may not invest more than 5 percent of their assets in a single issuer.

: Money funds must limit their investments to securities that are rated in one of the two highest short-term rating categories by a nationally recognized statistical rating organization (NRSRO). Investment in second-tier securities is limited to 3% of total fund assets, with a limit of 0.5% for any single issuer. Investment in second tier securities is restricted to maturities of 45 days or less.

Under the 2014 final rules,19money funds are divided into three classes: institutional, retail, and government. Institutional money funds must have a floating NAV based on market values. The rules also provide for liquidity (redemption) fees and gates (suspended redemption) during periods of market distress. In summation:

A fund may impose a fee of up to 2% on redemptions if a funds weekly liquid assets fall below 30% of its total assets.

A fund must impose a 1% fee on redemptions (with the option of imposing a fee of up to 2%) if a funds weekly liquid assets fall below 10% of its total assetsunless the funds board determines a fee would not be in the funds best interest.

A fund may impose a gatethat is, suspend redemptionsfor up to 10 business days in a 90-day period.

The fees and gates rules only apply to retail and institutional funds, although government funds may voluntarily adopt them if the fees and gates are previously disclosed to investors.

Money market funds are mutual funds that invest in short term (less than one year) money market instruments. Money market fund investments includetreasury bills, commercial paper, bank CDs and banker acceptances. By design, they are meant to maintain stable net asset valuations of 1.00 dollar per share and provide investors with interest dividends. They are thus suitable investments for savings and other short term needs. While money market funds are low risk, they are not zero-risk. In the event that some of the underlying investments default, the fund may not be able to maintain anet asset valueof $1.00/share; this failure is colloquially known asbreaking the buck. As of November, 2009, there have been only afew caseswhen this has actually happened. Most notably, two money-market funds of The Reserve Fundsbroke the buckin September, 2008, after Lehman went bankrupt.

Money funds are characterized by the underlying investments comprising the portfolio. This specialization allows for funds to be differentiated by risk and tax characteristics. Money funds include:

: These funds invest in a large gamut of money fund instruments:treasury bills, CDs, Yankee CDs, Eurodollar CDs,commercial paper, andbankers acceptances. These funds are usually heavily weighted towards the non-treasury instruments. Since these instruments are exposed to credit risks, they provide higher interest coupons than treasuries (this excess interest can be called the default risk premium). The non-treasury component of a General money market fund is taxable income for both federal and state jurisdictions.

: Treasury money funds invest 100% in full faith and credit treasury bills and agency instruments. Thus they are not subject to credit risk (since the treasury has monopoly power to print fiat currency.) Treasury interest is exempt from state income taxation.

: These funds invest in municipal money market instruments. The interest is generally exempt from federal taxation (although some interest may be subject to the alternative minimum tax).

State specific tax exempt funds invest in municipal securities of an individual state and thus provide federal, state, and sometimes local tax exempt interest for state residents. Tax exempt funds are subject to credit risk as well as the risk of tax law change to their exemption status.

If held in a taxable account, one needs to compare the after tax yields of a given money fund to determine whether the fund will yield the highest after tax income(seeAfter-tax yields).

Costs are an important factor in money market fund selection. Since the total return of a money market fund consists of the income payment, the lower the expense ratio of the fund, the higher the net return to the investor. A low cost money fund can hold the highest quality money market instruments and still provide competitive yields.

Bond mutual funds invest in fixed income securities with maturities ranging from one year to thirty (or more) years. Bond funds may hold the followingtypes of bonds:

Each of these general bond categories contain discrete segments of the bond market. Bond funds may hold an aggregate of the taxable or tax exempt bond markets, or may hold just a specific segment of the market. The segments of the bond market are outlined in the following table.

Bond funds are distinguished by the types of bonds held in the portfolio, the credit quality21of the bonds, and by theaverage maturityof the bond portfolio. As a general rule, lower quality and longer maturity bonds provide higher interest coupons as compensation for the addedrisk. Treasury securities have the highest credit quality. Corporate, asset-backed, and tax-exempt bonds are subject to various default and other risks and are rated by rating agencies for credit worthiness. Ratings range from investment grade (the highest rating) to bonds in default.

Typically, a bond fund in any given segment of the market will be a part of a series of funds providing short, intermediate, and long term maturities. These tiered maturity portfolios allow an investor to match a bond fund to an expected holding period, and to maintain the portfolios exposure to interest rate risk. Bond funds are usually available in the following maturities:

A fund will have an average maturity based on the proportion of fund assets represented by each bond held in the portfolio.

The two main risk characteristics of a bond fund, credit quality and maturity, are often graphically presented in a Morningstar style box, an example of which is included in Figure 1.

The fact that bond funds distribute income often means that taxable bonds are candidates for tax deferral in tax advantaged accounts(seePrinciples of tax-efficient fund placement). For taxable accounts, some bonds have tax preferences. Treasury securities are generally exempt from state income tax. Tax exempt bonds are generally exempt from federal taxation and, to the extent that the bond is issued by ones state of residence, may also be exempt from state and local taxation (although some interest may be subject to the alternative minimum tax).22These tax preferences often result in lower yields for treasury and municipal bonds in comparison to corporate and other non-preference bonds. One needs to compare the after tax yields of a given fund to determine whether the fund will yield the highest after tax income(seeAfter-tax yields).

Costs are a critical factor in long term bond fund performance. A low cost bond fund can hold higher quality, less risky bonds and still provide higher long term returns than many higher cost funds holding lower quality bonds.

Stock mutual funds are extremely diverse. There are funds that invest in the American stock markets; funds that invest ininternational markets; funds that investglobally. Within each market, there are funds that invest in the entire market; funds that invest in specific segments of the market; and even funds that specialize inspecific industry sectorsof the market.

Stocks funds are often classified by the average size of the companies they hold as investments. This is most commonly done by looking at the market capitalization of a firm.Market capitalizationis simply a measurement found by taking a stocks current share price and multiplying it by the number of stock shares outstanding.

Exact market cap ranges will vary among different financial and rating institutions, but there are three different terms commonly used to describe stocks by their general size.

While these are the most common market cap references, there are also some less commonly used: mega cap (greater than $200 billion), micro cap ( between $50 million and $300 million), and nano cap (below $50 million). Market cap terms are relative and are constantly changing as companies get bigger and smaller.

Stock funds may also be classified by style, either Growth, Value, or Blend. Growth stock funds invest in companies that are growing their profits at a very fast rate and are expected to continue to grow at an increasing rate. Value stock funds seek stocks that tend to trade at deep discount relative to their intrinsic value (as defined by profits, book value and other measures). Blend funds tend to hold a mixture of growth and value stocks.

The combination of size and style metrics allows a fund to be classified in a Morningstar Equity style box (see Figure 2.)

In addition to size and style classifications, some international stock funds are specialized by regions. The most common regional fund classifications are:

International Developed Market funds usually combine the European and Pacific regions.

Balanced funds (sometimes also referred to as hybrid funds) invest in a portfolio that includes stocks and bonds, and sometimes cash and commodities. Usually these type funds have a fixed asset allocation mix, generally with moderate (60 percent stock/40 percent bond) or conservative (40 percent stock/60 percent bond) equity allocations. Balanced funds also include the following types of funds:

: These funds can be designed to hold a fixed asset allocation of asset classes, but are commonly funds which allow a fund manager to shift allocations according to atactical asset allocationstrategy.

: These funds usually offer portfolios that hold a static asset allocation, usually labeled as growth, moderate, conservative, and income portfolios. These funds are often designed as fund of funds (see below).

: These funds are designed primarily for retirement plans. They are usually designed as fund of funds (see below).

Balanced funds offer the advantage of a simplified investment program. The portfolios include multiple asset classes and are self-balancing. However, investors whose portfolios are divided between taxable accounts and tax deferred/tax free accounts often eschew balanced funds in favor of separate asset class funds, allocated across accounts usingprinciples of tax-efficient fund placement.

A fund of funds differs from most mutual funds in that the fund invests in mutual funds as opposed to investing in individual securities. Fund of funds are primarily designed forretirement plansandeducation savings plans. Fund of funds have two basic forms:

: These portfolios hold a steady predetermined allocation mix of stock funds, bond funds, or a balanced mix of stock and bond funds. A variation on this type fund allows a manager to shift the stock/bond/cash allocation according to atactical asset allocationstrategy.

: These fund of funds hold a targeted asset allocation that over timegrows more heavily weighted towards bondsas the target date (for retirement or college matriculation) approaches. Thesefundsare commonly used incorporate retirement plansand in the529 planmarket.

Fund of funds may use funds from the same advisory firm, or the fund manager (usually with an added management fee) may select funds from different advisors.

Fund of funds have what is known as anacquired fund fee, a measure which includes the weighted expense ratio of the underlying funds as well as any additional expense ratio imposed by the investment manager.

Indexing is an investment management strategy that attempts to replicate the investment performance of a market index. An index is a statistical measure of a markets value and performance and serves as a benchmark against which an investment managers performance is judged.23. Today, a large number ofindex providers, including ,S&P, Dow Jones, MSCI, Russell, FTSE, CRSP and Morningstar, provide a wide range of indexes coveringUSandinternationalstocks,bonds, andcommodities. A well managed, low cost index fund offers investors an excellent, if not optimal, investment vehicle for investing in the overall stock market, in discrete market segments, in the bond markets, and in the commodity markets.

Figure 3: Investment growth of both a low-cost and high-cost fund

: According to the Investment Company Institute

, the average expense ratio for US stock mutual funds in 2014 was 1.33% (weighted average 0.70%, while the average expense ratio for US bond mutual funds was 0.98% (weighted average 0.57%).

Index funds are available to investors for expense ratios of 0.20% and lower from firms such asVanguard

and manyexchange-traded funds. These low expenses mean that a greater portion of market returns accrue to the mutual fund shareholder where they can continue to compound, as opposed to being siphoned off through intermediaries. As figure 3. demonstrates, indexings cost advantage builds steadily over long holding periods. In addition to low expense ratios, index funds can provide low transaction costs, which include brokerage commission costs

,bid/ask spreads, and market impact costs (institutional purchases and sales can drive the price of a security up or down before the order is filled.)

: Due to lower fund turnover and longer holding periods, stock index funds tend to exhibit greater tax efficiency than actively managed stock funds. This is especially true for total market index funds, large cap index funds, and large growth index funds. These funds rarely realize and distribute a capital gain (and any small capital gains distributions are usually long term gains taxed at reduced tax rates.) The deferral of capital gains tax liabilities results in a tax-efficient index fund providing higher after tax returns to investors.

In addition, since the advent of the tax regime forqualified dividendsin 2004, well-managed total market and large cap indexes have been successful in providing investors with 100% qualified dividends, which are taxed at lower tax rates

: Index funds are designed to provide the returns of the asset class they are tracking. This allows an investor to control the asset allocation decision.

: Actively managed funds expose investors to two manager risks.

The risk that the manager will under perform the benchmark return,

The risk that the manager will leave the fund. For taxable investors, selling a stock fund after a manager change could result in a large capital gains tax.

The risk of under performing a benchmark return is greatly reduced.

Index funds are managed by an investment team. The departure of a fund manager does not affect the management of the fund.

: The low cost, high tax efficiency, and long term consistency of performance advantages of indexing greatly simplify the task of fund selection and fund monitoring in an investment plan.

The following table and charts show the distribution of long term assets held in load funds, no-load funds, and variable annuity subaccounts Variable annuity subaccounts, while not technically organized as a mutual fund, are diversified investment funds used by insurance companies. Some employer provided plans use variable annuity subaccounts as funding vehicles. Subaccounts are also available in variable annuities. In addition to fund management charges, a subaccount will usually have additional insurance related charges. Over the period measured there has been a steady increase in investor no-load fund holdings and a decrease in load fund holdings. (The numerical data is in billions of dollars). Source:ICI Mutual Fund Fact Books. Retrieved 09 May 2019.

(View Google Spreadsheetin browser, then File —

Both funds assume an initial $10,000 investment and an identical 8% annual growth. The time period is 30 years. The low-cost fund is no-load and has expenses of 0.2% per year. The high-cost fund has an initial 5.75% sales load, expenses of 2.0% per year, and a 0.25% 12b-1 fee.

Mutual Funds,, viewed September 09, 2015.

The Relentless Rules of Humble ArithmeticJohn Bogle, Financial Analysts Journal; November/December 2005 CFA Institutes Bold Thinking on Investment Management: The FAJ 60th Anniversary Anthology, 2005

, Yale University Press, p.154. IBSN 0-300-10990-3

, Yale University Press, p.184. IBSN 0-300-10990-3

The Arithmetic of Mutual Fund Investing is More Important Than EverJohn Bogle, American Association of Individual Investors Philadelphia Chapter, May 24, 2005, Valley Forge, PA

On the Mergers and Acquisitions of Mutual Fund Families: The Determinants and Subsequent Impact on Fund Performance

Mutual Funds: How a Profession with Elements of a Business Became a Business with Elements of a ProfessionJohn Bogle, At Boston Security Analysts Society Boston, Massachusetts,February 24, 2006

SEC Invest Wisely: An Introduction to Mutual Funds

SeeVanguard Passive Fund Brokerage Commissionsfor data

SECInvest Wisely: An Introduction to Mutual Funds

Overview Of The Mutual Fund IndustryRichard Loth , Investopedia

Explain A, B, C share classes of load funds, please, forum discussion. Tutorial on the various share classes.

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Asking portfolio questions•Behavioral pitfalls•Importance of saving early•Investment philosophy•Investment policy statement•Percentage gain and loss•Risk

Bonds•Callan periodic table of investment returns•CDs•Domestic/International•Money markets•Stocks•Treasury Inflation Protected Securities

Index fund•Indexing•Lazy portfolios••Mutual funds and fees•Mutual funds: additional costs•Vanguard target retirement funds

Accounts for children•Asset allocation•Asset allocation in multiple accounts•Comparing investments•Managing a windfall•Prioritizing investments•Rebalancing•Tax loss harvesting•Tax-efficient fund placement•Taxable account

Financial planner•Investment adviser•Robo-adviser

Asking portfolio questions•Behavioral pitfalls•Importance of saving early•Investment philosophy•Investment policy statement•Percentage gain and loss•Risk

Bonds•Callan periodic table of investment returns•CDs•Domestic/International•Money markets•Stocks•Treasury Inflation Protected Securities

Index fund•Indexing•Lazy portfolios••Mutual funds and fees•Mutual funds: additional costs•Vanguard target retirement funds

Accounts for children•Asset allocation•Asset allocation in multiple accounts•Com