3 Common Questions About Mutual Funds

Nearly a third of the U.S. population invests in mutual funds, but even though funds are popular, they aren’t always well understood. Our firm has been investing in funds since 1969, and we’ve found that there are three areas that tend to trip up even experienced investors: trading, expenses and distributions.

If people are selling shares of a fund that means other people are buying those shares, right?

Not exactly. When you buy or sell shares of an open-end mutual fund, you’re trading with the fund itself, not other investors. If you sell your fund shares, the fund redeems your shares at net asset value (NAV, or share price). If you buy fund shares, the fund issues new shares at that day’s NAV. A fund’s share price or NAV is the total value of the fund’s underlying portfolio minus expenses and divided by the number of outstanding shares. (Exchange-traded funds are different: while these funds have a calculated NAV, they are traded like stocks. Published prices are typically reported as the last price of the trading day.) 

How am I billed for fund expenses?

If you invest in mutual and exchange-traded funds, you’re paying fund expenses. All funds have expenses, which typically include a management fee and operating and administrative costs. However these are paid indirectly, meaning that when you invest in a fund, you won’t be billed for the expenses. Instead, a portion of the expenses are taken out of a fund’s total assets on every trading day when the fund is priced. This way you only pay a fund’s expenses for the time that you’re invested in the fund.

Because expenses are taken into account before a fund prices, mutual fund performance returns are always reported net of (including the full impact of) expenses.  

Why is a fund’s performance different on Yahoo Finance than on the fund’s website?

Performance discrepancies often come down to whether or not distributions are taken into account. Mutual funds distribute capital gains and income to shareholders. For equity funds this usually occurs annually, toward the end of the year. When a fund pays out capital gains or income, its share price, or NAV, is reduced by the amount of the distribution. This can make it look like the fund’s performance suddenly fell off a cliff. But although a fund’s NAV is lower on the day it makes a distribution, investors own more shares at the end of the day (or have additional cash), which makes up for the difference in share price.

Distributions should be included in a fund’s total returns, but some pricing services (and Yahoo Finance is one common example) are slow to catch distributions and may report a fund’s returns incorrectly. This is particularly vexing with bond funds, whose dividends often represent most or all of a fund’s gain over time. If a reporting service omits those dividends, the returns you see on their charts can be way off. For accurate performance data, it’s better to rely on the fund’s website. 

Structure of a Mutual Fund

When you invest in a mutual fund, it may feel like it’s a transaction between you and the fund’s portfolio manager, but the reality is that you are investing in a team of people, all of whom are working for you. If you initially send in a check to a fund company, the check is delivered to the fund’s custodian (usually a bank). The custodian is responsible for holding a fund’s assets. The fund’s portfolio manager or investment advisor then directs how these assets are to be invested. The fund’s transfer agent maintains a record of your investment and makes sure you are set up to receive shareholder mailings and any distributions of dividends and capital gains, while the fund’s accountants calculate the fund’s NAV and performance.

Five key parts of your mutual fund team:

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