Diversify Your Holding – Choose from the Pooled Investments

by Shane Flait, ©2008

When you invest you should choose a mix of the 3 asset category types: stocks, bonds, and cash. The younger you are you should weight most of you portfolio to stocks for their growth potential. Restrict cash equivalents (bank accounts, CDs, money market funds, etc) to 6 months of living costs.

But you still need to diversify within each category – at least the growth and income type assets. This protects your portfolio from heavy reliance on any one company (stock or bond) that may fail or default. You can best diversify by investing in one or more types of investment fund companies that pool money from investors and diversify within their category of investments they buy. They all seek to supply one or more of the category objectives of appreciation, income, at different levels of risk.

Here are some examples of pooled investments types[1] of investment companies:

·         Mutual funds (MFs) are ‘legally’ called open-end companies

·         Closed-end funds –are not MFs.

·         Unit Investment Trusts (UITs) – are not MFs

·         ETFs  are not MFs but can have a close-end or an open-end structure

·         Hedge funds, and Funds of hedge funds are not MFs

I’ve qualified all the funds except mutual funds as ‘not’ a mutual fund. A mutual fund - called an open-end company - invests its pooled money in stocks, bonds, and short-term money-market instruments depending on its objective. Each share of a mutual fund is an investor’s proportionate ownership in the fund’s portfolio and the income it generates.

These portfolios are managed by separate entities known as investment advisors that are registered with the SEC. For the protection of investors they are subject to numerous SEC regulations that:

·         require a certain degree of liquidity,

·         mutual fund shares be redeemable at any time,

·         protect against conflicts of interest,

·         assure fairness in the pricing of fund shares,

·         force disclosure,

·         limit the use of leverage,

·         and more.

Closed-end funds sell a fixed number of shares at one time (as an initial public offering - IPO) and then trade on the secondary market at below or above their net asset value. Of course they pool the money they receive on the initial offering by purchasing a diversified portfolio of underlying stocks or bonds appropriate for their overall investment purpose.

UITs make a one-time public offering of only a specific, fixed number of redeemable securities called ‘units’. They pool the money they receive to buy a diversified group of bonds. They will terminate and dissolve on a date specified at the UIT’s creation.

An Exchange-traded fund (ETF) is a type of investment company that aims to achieve the same return as a particular market index. They do this by buying most of the stocks that constitute that particular market index. They can be either open-end or UITs.  

A Hedge fund is a non-legal term used to describe private, unregistered investment pools that traditionally have been limited to sophisticated, wealthy, investors. Funds of hedge funds –also not mutual funds - are investment companies that invest in hedge funds. Some, but not all, register with the SEC and file semi-annual reports.  They offer very limited rights of redemption. And unlike ETFs, their shares are not typically listed on an exchange.

Be aware that the ‘rules’ of each of these are different. You should investigate each fund’s rules concerning:

• share or unit redeemability
• regulations to abide by
• fee structure, and
• array of investment objectives

Shane Flait is a writer and educator. Get more info at www.EasyRetirementKnowHow.com