Mutualised investment vehicles: definition and types
A common investment vehicle is a way to put your money on the stock market alongside other investors. There are several ways you can pool money if you are looking for an alternative to individual stock trading. Some are better known than others and they each have their advantages and disadvantages. As you shape your portfolio and pursue your investment objectives, think about what joint investments could do for you.
What is a mutualized investment vehicle?
In general, a mutualized investment vehicle is a vehicle in which several investors participate. Each investor adds money to the pool to buy shares of the investment. Basically it is a large portfolio funded by multiple investors. Returns are made in the form of dividend or interest distributions and / or price appreciation as the price per share of the investment increases.
Joint investments are supervised by a management team. This team makes decisions on which securities to buy or sell as part of the investment. In return, investors pay a expense rate to hold the investment. This expense ratio reflects the cost of owning the fund on an annual basis.
You can buy pooled investments through a taxable brokerage account or via a tax-efficient account, such as that of your employer 401 (k) plan or individual retirement account. If you are investing through an employer-sponsored plan, your range of investment options will be determined by the plan administrator. If you are investing through an IRA or taxable account, the fund choices are dictated by the brokerage that holds your account.
Types of joint investments
There are several avenues you can take to pool your investment dollars. You may be more familiar with some than others.
1. Mutual funds
Mutual fund are a type of open-ended investment that can include stocks, mutual funds, bonds, or other investments. A open fund means that the company owning the fund can create new shares on demand to sell them to investors. When an investor owns their shares, the fund can redeem them.
A mutual fund can be actively or passively managed. An actively managed fund means that the fund manager actively makes decisions about which investments to buy or sell within the fund. Passive funds can track an index, such as the S&P 500 or the Nasdaq, and try to match its performance. These funds generally have a lower expense ratio than actively managed funds.
2. Exchange traded funds (ETFs)
A exchange-traded funds (ETFs) combines the characteristics of a mutual fund and a stock. On the fund side, ETFs hold a collection of investments. This can include stocks, bonds, real estate, and commodities. What’s different is that even though mutual funds are priced once a day when markets close, ETFs trade throughout the day on an exchange just like a stock.
ETFs can also be actively or passively managed. Compared to mutual funds, active and passive ETFs tend to have lower expense ratios. Passively managed ETFs can also be more tax efficient because the fund holdings are renewed less often. This translates into fewer capital gains tax events for investors.
3. Hedge funds
A hedge funds is a collective investment vehicle managed by a registered fund manager or investment adviser. The fund manager is responsible for using investor funds to buy and sell investments, according to a defined strategy. For example, there are hedge funds that are fund of funds, others that invest exclusively in emerging markets, and others that focus solely on real estate.
Hedge funds can offer diversification because hedge fund managers can pursue investment strategies that may not be an option with mutual funds or ETFs. The downside is that they can be more expensive when it comes to fees. They can also be less liquid, potentially making it harder to sell stocks if necessary.
4. Closed-end funds
Closed funds work the opposite of open funds. With this type of fund, the number of shares available to investors is limited. These funds are most often associated with an initial public offering (IPO) when a company first offers stocks on the open market. It is a way for startups to raise capital to finance their future growth.
A closed-end fund could generate better returns than an open-end fund if the company performs well. The downside is that they can also be more volatile and it can be difficult to calculate an accurate estimate of the true value of a business.
5. Real estate investment funds (REITs)
A real estate investment trust or REIT is a way for investors to own real estate without actually owning it. A REIT company buys properties to invest in and then you buy shares of the REIT. These types of bundled investments can hold a wide range of property types including hotels and resorts, public storage units, commercial office buildings, apartments, and single family homes.
Besides not having to deal with the headaches of being an owner, REITs can also offer income in the form of dividends and hedge against stock market volatility. You also get some of the tax benefits of owning real estate, such as depreciation.
6. Unit Investment Trusts (UIT)
A mutual fund (UIT) is something you might not have heard of, but it falls under the category of joint investment. An ITU is a company that purchases stocks, bonds and other securities and then offers them to investors in the form of redeemable units. ITUs differ from open-ended or closed-end mutual funds in that they have an expiration date. Once this date is reached, the ITU is dissolved and the assets are distributed among the investors in proportion to their share of ownership.
Advantages and disadvantages of mutualised investment vehicles
Investing in mutual funds, REITs, or UITs can offer many benefits. Diversification is a no-brainer, because owning a common investment can give you exposure to multiple asset classes and sectors in one vehicle. The more diversified you are, the better equipped you are to manage your portfolio risk.
Pooled investments can also be more convenient and accessible, compared to investing in individual stocks. Typically, employer-sponsored pension plans don’t allow you to buy individual stocks, but you may be able to invest in those same stocks through a mutual fund or ETF. A common investment vehicle also offers investors the opportunity to invest in opportunities that are generally only available to large-scale investors. Buying a mutual fund through a brokerage account can also be an easier way to focus on a particular industry.
Buying and holding pooled investments can also be more profitable compared to commercial actions. Brokerage accounts may charge commission fees for transactions, so frequent buying and selling could eat into your returns.
Generally speaking, the downsides to watch out for with joint investments include volatility and liquidity risk. Some types of pooled investments are more liquid than others, which you need to be aware of if you don’t want to tie up a large amount of money in one place. Individual investments can also be more volatile than others, depending on their underlying holdings.
The bottom line
Pooled investment vehicles can take different forms and some may be more attractive than others. Checking the performance, fees, risk ratio and underlying holdings of any common investment vehicle is essential to determine whether to buy. With a little research, you may be able to diversify your portfolio and achieve your goals in no time.
Advice to investors
Remember to take a fund’s tax profile into account when investing. For example, a passively managed ETF that has less capital gains events might be better suited to your taxable brokerage account, while actively managed funds might be better kept in your IRA or 401 (k). The goal is to manage your investments with tax efficiency so that you can potentially minimize the amount of tax you owe on earnings over time.
Consider speaking with a financial advisor about the benefits of pooled investment vehicles. Find the right financial advisor who adapts to your needs doesn’t have to be difficult. The free tool of SmartAsset connects you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you reach your financial goals, start now.
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