A mutual fund company combines money from many people to make investments in stocks, bonds, money market instruments or some combination of these. Investors deal directly with the fund company or go through a broker, but they don't make their purchase from other investors or on a securities market. The smallest portion of ownership in a mutual fund is called a unit and represents your proportion of the company's investments.
A unit in a mutual fund company is also called a share or unit share. Normally mutual funds are open-ended, which means the company issues more shares whenever investors want to buy. The value of a unit is available on financial websites and fluctuates every day according to calculations by the fund company. When you buy units in a mutual fund, your cost may include a sales charge. When you sell, you may also pay a fee in some cases.
The value of each unit or share depends on the value of the assets of the mutual fund company less its liabilities. The total assets minus liabilities is called the net asset value, or NAV, and is normally computed every day at the close of business. The NAV of one unit equals the total NAV of the mutual fund divided by the number of shares. For example, if a fund's net asset value equals $10 million, and the fund has issued 1 million units, each unit is valued at $10.
Mutual fund owners get the advantage of diversification and professional oversight, often with a small initial investment. As owners, they receive a portion of the capital gains or income from the company's investments. If the investments make money after expenses, shareholders receive that profit as distributions of income or capital gains. You can choose whether to take these profits out or reinvest them for more units in the mutual fund.
Taxes and Risks
You must pay annual taxes on the income from your units unless they are in a tax-deferred retirement account. If the fund has earned capital gains by buying and selling securities, you may owe capital gains taxes. Share prices can go down as well as up, depending on the performance of the stocks or bonds in the fund's portfolio. If you need your money when unit prices are down, you may have to sell at a loss. Even if you sell your units at a profit, you'll owe capital gains taxes on the increase in share price.