Skip to main content
diversification.com
← Back to I Definitions

Investment units

What Are Mutual Fund Shares?

Mutual fund shares represent investment units in a type of professionally managed pooled investment vehicle that gathers money from many investors to purchase securities. As an essential component of the broader category of investment vehicles, mutual funds are managed by professional fund managers who allocate the collective capital across a diversified portfolio of stocks, bonds, or other assets, aiming to achieve specific investment objectives. When an investor buys into a mutual fund, they purchase mutual fund shares, effectively becoming a shareholder in the fund's underlying holdings. These shares are not traded on exchanges like stocks but are bought directly from the fund company or through brokers, and their value is determined by the fund's net asset value (NAV). Mutual fund shares are popular for their potential for diversification and professional management.

History and Origin

The concept of pooled investment, which forms the basis of mutual funds, has roots in 19th-century Europe, with early investment trusts emerging in Britain. However, the modern mutual fund, as we know it today, largely developed in the United States. The first mutual fund was established in Boston in 1924, and the idea gradually gained traction, offering investors a way to achieve diversification even with limited capital. The industry expanded, but the lack of comprehensive regulation led to concerns following the stock market crash of 1929.

In response to these concerns and the subsequent Great Depression, the U.S. Congress enacted the Investment Company Act of 1940. This landmark legislation fundamentally shaped the mutual fund industry, providing a regulatory framework for investment companies that engage in investing, reinvesting, and trading in securities95. The Act requires these companies to disclose their financial condition and investment policies to investors and minimizes potential conflicts of interest94. Joseph Mansueto founded Morningstar in 1984, which became a significant source for independent fund data and analysis, further enhancing transparency and investor access to information about mutual funds.

Key Takeaways

  • Mutual fund shares represent proportional ownership in a professionally managed portfolio of securities.
  • The price of mutual fund shares is based on the fund's Net Asset Value (NAV), calculated daily at the close of trading.
  • Mutual funds offer investors instant diversification and professional investment management.
  • Investors in mutual funds may receive distributions from income (dividends, interest) and capital gains generated by the fund's underlying holdings.
  • Mutual fund shares are subject to various fees and expenses, which can impact overall returns.

Formula and Calculation

The value of a mutual fund share is determined by its Net Asset Value (NAV), which is calculated once per trading day, typically after the close of the major financial markets. The NAV per share is derived by taking the total value of the fund's assets, subtracting its liabilities, and then dividing that amount by the number of outstanding shares.

The formula for NAV per share is:

NAV per Share=Total Assets−Total LiabilitiesTotal Number of Shares Outstanding\text{NAV per Share} = \frac{\text{Total Assets} - \text{Total Liabilities}}{\text{Total Number of Shares Outstanding}}

Where:

  • Total Assets represents the market value of all securities and other holdings in the fund's investment portfolio.
  • Total Liabilities includes accrued expenses, management fees, and other obligations of the fund.
  • Total Number of Shares Outstanding is the total count of all mutual fund shares held by investors.

This calculation ensures that new investors buy into the fund at a fair market price and existing investors can redeem their shares at an accurate valuation.

Interpreting Mutual Fund Shares

Understanding mutual fund shares involves more than just their current NAV. Investors interpret mutual fund shares by examining various factors that reflect the fund's underlying strategy, performance, and cost structure. Key metrics include the fund's historical performance, which indicates how well the fund has met its investment objectives over time. However, past performance is not indicative of future results.

The fund's expense ratio is another crucial element. This ratio represents the annual percentage of fund assets paid for management fees and operating expenses. A lower expense ratio generally means more of the investment return is retained by the investor. Additionally, the fund's investment style and the composition of its investment portfolio provide insights into its risk profile and potential for growth or income generation. Investors often look at the types of distributions a fund makes, such as dividends from income or capital gains from asset sales, as these impact taxable income and overall returns.

Hypothetical Example

Imagine an investor, Sarah, wants to invest in a diversified portfolio without picking individual stocks. She decides to invest in the "Global Growth Mutual Fund" by purchasing mutual fund shares.

  1. Initial Investment: Sarah invests $10,000. On the day she invests, the Global Growth Mutual Fund has a NAV per share of $20.
  2. Shares Purchased: Sarah purchases ( $10,000 / $20 = 500 ) mutual fund shares.
  3. Fund Performance: Over the next year, the fund's underlying holdings perform well. The fund receives dividends from its stock holdings and realizes capital gains from selling some appreciated securities.
  4. Distributions: At year-end, the Global Growth Mutual Fund distributes $0.50 per share in dividends and $0.75 per share in capital gains to its shareholders. Sarah, owning 500 shares, receives ( 500 \times $0.50 = $250 ) in dividends and ( 500 \times $0.75 = $375 ) in capital gains. These amounts are generally taxable to her, regardless of whether she receives them as cash or reinvests them93.
  5. NAV Adjustment: On the day of the distribution, the fund's NAV per share drops by the total distribution amount ($0.50 + $0.75 = $1.25). So, if the NAV was $21.50 just before the distribution, it would become $20.25 immediately after, assuming no other market changes92.
  6. Current Value: Sarah's 500 mutual fund shares are now worth ( 500 \times $20.25 = $10,125 ). Her total return includes both the distributions received ($625) and the current value of her shares ($10,125), for a total of $10,750 before taxes on the distributions.

Practical Applications

Mutual fund shares are widely used by individual investors and institutional clients for various financial goals due to their ease of access, professional management, and inherent diversification.

  • Retirement Planning: Mutual funds are a cornerstone of many retirement accounts, such as 401(k)s and Individual Retirement Accounts (IRAs). Their diversified nature helps mitigate risk over the long term, which is crucial for retirement savings.
  • Long-Term Investing: For investors seeking growth over extended periods, equity mutual funds that focus on stocks can provide exposure to various sectors and geographies. Bond mutual funds are often used for income generation and portfolio stability.
  • Goal-Based Investing: Investors frequently use mutual funds to save for specific objectives like a down payment on a house, a child's education, or other significant life events.
  • Tax Considerations: Distributions from mutual funds, whether as ordinary dividends or long-term capital gains from the fund selling its holdings, are generally taxable to the shareholder in the year they are received, even if reinvested91. The Internal Revenue Service (IRS) provides detailed guidance on the taxation of mutual fund distributions90.
  • Portfolio Construction: Financial advisors often recommend mutual fund shares as core holdings in client portfolios, adjusting the mix of equity, bond, and money market funds to align with an investor's risk tolerance and financial objectives.

Limitations and Criticisms

While mutual fund shares offer significant benefits, they also come with limitations and have faced criticisms.

One primary criticism revolves around fees and expenses. Mutual funds charge various fees, including management fees, administrative fees, and sometimes sales charges (loads). These expenses, collectively represented by the expense ratio, can significantly erode investor returns over time, even if a fund performs well89. Some academic studies suggest that higher fees do not consistently correlate with better performance, particularly in actively managed funds, leading to concerns that investors may be overcharged87, 88. The complexity of fee structures can also make it difficult for investors to fully understand the total cost of ownership86.

Another limitation is the lack of intraday trading. Unlike stocks or exchange-traded funds (ETFs), mutual fund shares are typically priced only once a day at the market close, based on their NAV. This means investors cannot react immediately to market fluctuations throughout the day. Furthermore, while diversification is a core benefit, it can also lead to "closet indexing," where an actively managed fund's portfolio closely mirrors a market index, yet still charges higher active management fees. This can diminish the value proposition of active investment management.

Mutual Fund Shares vs. Exchange-Traded Funds (ETFs)

Mutual fund shares and exchange-traded funds (ETFs) are both popular pooled investment vehicles, yet they have distinct characteristics that differentiate them. The primary distinction lies in how they are traded and priced.

Mutual fund shares are bought and sold directly from the fund company at their net asset value (NAV), which is calculated once per day after the market closes. This means all transactions (purchases and redemptions) occur at the same daily price. ETFs, on the other hand, trade like individual stocks on major exchanges throughout the trading day. Their prices fluctuate based on supply and demand, potentially deviating slightly from their underlying NAV.

This difference in trading mechanism leads to several implications: ETFs offer intraday liquidity and price discovery, allowing investors to buy or sell at any point during market hours. Mutual funds, by contrast, are best suited for investors who prefer to transact once a day and may not need constant liquidity. Additionally, ETFs often have lower expense ratios compared to actively managed mutual funds, particularly for passively managed index ETFs. However, ETF investors may incur trading commissions, whereas many mutual funds offer no-load shares without sales charges.

FAQs

Q: How do I buy mutual fund shares?

A: You can typically buy mutual fund shares directly from the mutual fund company, through a brokerage firm, or via a financial advisor. Most platforms allow you to set up an account and then choose the specific fund you wish to invest in.

Q: What is a "load" in mutual funds?

A: A "load" refers to a sales charge or commission associated with buying or selling mutual fund shares. A "front-end load" is paid when you purchase shares, while a "back-end load" (or contingent deferred sales charge) is paid when you sell shares, typically decreasing over time. "No-load" funds do not charge these sales commissions.

Q: Are mutual fund shares diversified?

A: Yes, one of the primary benefits of mutual fund shares is the immediate diversification they offer. By pooling money from many investors, a mutual fund can invest in a wide range of securities across various industries, asset classes, and geographies, reducing the risk associated with investing in a single stock or bond.

Q: How are mutual fund distributions taxed?

A: Distributions from mutual funds, including ordinary dividends, short-term capital gains, and long-term capital gains, are generally taxable to the shareholder in the year they are distributed, even if they are reinvested into additional shares of the fund. The tax rate depends on the type of distribution and the investor's individual tax bracket.

Q: Can I lose money investing in mutual fund shares?

A: Yes, like all investments in financial markets, investing in mutual fund shares carries risk. The value of your mutual fund shares can decrease if the underlying investment portfolio performs poorly due to market downturns, economic changes, or specific issues with the companies or assets held within the fund. There is no guarantee of return or principal.12, 3, 4, 56, 7, 8910, 11, 12, 13, 14, 15, 161718, 19, 20, 21, 2223, 24, 252627, 28, 29, 3031, 323334, 3536, [37](https://www.bankrate.com/investing/wh[82](https://groww.in/p/nav), 83at-is-net-asset-value/), 383940[41](https://www.finr[78](https://www.finra.org/investors/investing/investing-basics/asset-allocation-diversification), 79, 80, 81a.org/investors/investing/investing-basics/asset-allocation-diversification), 4243, [44](https://groww.in/p[74](https://www.schwab.com/etfs/understand-etfs), 75, 76, 77/nav)[45](https://vertexaisearch.cloud.google.com/grounding-api-redirect/AUZIYQFgfwy1An_47yjYOsnn[72](https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/investment-portfolio/), 73dZXdSybmOLqKIrEYo6oFcMIEIpC_s0sf14tGDWXstsHWObk7amEjkz3281IRS5XHhMNgJ6FIxVhGDYIlRf1OonIkJmUymUmIH161g8nbFz0DfcxoyIXixb5QN-fmKjTL6kx2a69775ph), 46, [47](https://investor.vanguard.com/investor-resources-education/po[70](https://groww.in/p/nav), 71rtfolio-management)48, 49[50](https://www.schwab.com/etf[68](https://www.wallstreetprep.com/knowledge/net-asset-value-nav/), 69s/understand-etfs)5152, 535455, [^64, 65, 66, 6756^](https://smartasset.com/investing/what-is-an-investment-portfolio), [57](https://www.empower.com/th[62](https://www.wallstreetprep.com/knowledge/net-asset-value-nav/), 63e-currency/money/investment-portfolio)[58](https://corporatefinanceinstitute.com/resources/career-map/sel[60](https://www.wallstreetprep.com/knowledge/net-asset-value-nav/), 61l-side/capital-markets/investment-portfolio/), 59