Mutual funds: the types and how the share value is calculated

A few days ago, I described the basics of mutual funds. In this article, I will cover the basic types of different mutual funds and how the value of a mutual fund "share" is calculated.

You can buy a mutual fund’s shares in a few different ways. Funds are often described as either "no-load" or "load" funds. The designation depends on whether or not the fund charges a sales commission.

  • Many funds are no-load funds that charge no (or a very low) sales fee or commission. No-load funds are typically sold directly to investors with ads in newspapers, magazines, and the Internet. In this case, you complete all the paperwork yourself.
  • Load funds charge a sales fee or commission for purchases. Some funds charge the fee when you buy shares; others charge when you sell them. Brokerage firms and banks often sell load funds.

You may wish to invest in mutual funds, in addition to individual companies. There are reputable funds in both categories. Because sales charges reduce your return, I recommend that investors purchase no-load funds over load funds whenever possible.

The value of a mutual fund share is calculated on the basis of the value of the assets owned by the fund at the end of every trading day. A share's value is called the Net Asset Value (NAV). The fund calculates the NAV by adding up the total value of all of the securities it owns, subtracting the expenses of the fund, and then dividing by the number of outstanding fund shares.

Since the value of stocks and bonds owned by the fund changes daily, the fund’s value will also change daily. Therefore, a mutual fund adjusts its price once every trading day to provide investors with the most current NAV. This is different from the price of stocks because:

  • The NAV updates only once at the end of the day as opposed to every second of the day with stocks.
  • The NAV is not directly tied to the whims and moods of the market. However, since the price of a mutual fund is determined by the sum of the value of all of its components, the various market moves (however logical or illogical) of stocks, bonds, and cash that the fund owns are ultimately reflected in the NAV.

While you cannot buy a fraction of a share of a company, you can have a fraction of a mutual fund share. This happens when the amount you invest does not divide evenly by the NAV. If you send the mutual fund company a check, the managers will divide that investment by the current NAV. This results in your number of shares in the fund, even if it is a fraction. This breaks the "share" concept and demonstrates that you are simply pooling your money into a large pool.

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