Take a Deeper Dive: How Mutual Funds Are Structured

Sometimes it's valuable to break the surface of a common investment. Let's dive deeper into the structure of mutual funds.

A mutual fund is an investment company that pools money from many investors and invests it based on specific investment goals.

Technically known as an "open-end company," a mutual fund raises money by selling its own shares to investors. Each share represents an ownership slice of the fund, and gives the investor a proportional right to income and capital gains that the fund generates from its investments, based on the number of shares he or she owns.

Here's something you probably didn't know: Mutual funds are equity investments, as individual stocks are. This is true of bond funds as well as stock funds, which means there is an important distinction between owning an individual bond and owning a mutual fund that invests in bonds.

When you buy an individual bond, you are promised a specific rate of interest and return of your principal. That's not the case with a bond fund, which owns a number of bonds with different rates and maturities. Your equity ownership of the bond fund provides you with a right to a share of what the fund (1) collects in interest, (2) realizes in capital gains and (3) receives back if it holds a bond to maturity.

The particular investments a fund makes are determined by its investment objectives and strategies, which are described in the fund's prospectus—and, in the case of an actively managed fund, by the investment style and skill of the fund's professional manager or managers. The holdings of the mutual fund are known as its underlying investments, and the performance of those investments, minus fund fees, determine the fund's investment return.

The price that investors pay for mutual fund shares is the fund's approximate net asset value (NAV) per share plus any fees that the fund may charge at purchase, such as sales charges, also known as sales loads.

Mutual funds generally sell their shares on a continuous basis. However, some funds will stop selling when they reach a certain level of assets under management, at which time the fund is closed to new investments.

Mutual fund shares are "redeemable." This means that when mutual fund investors want to sell their fund shares, they sell them back to the fund, or to a broker acting for the fund, at their current NAV per share, minus any fees the fund may charge.

Publicly offered mutual funds must be registered with the Securities and Exchange Commission (SEC). The investment portfolios of mutual funds typically are managed by "investment advisers" that are also registered with the SEC. You can check whether mutual fund investment advisers are registered with the SEC by using FINRA BrokerCheck.

Subscribe to FINRA's Investor News for more information about saving and investing.