Investment Companies (better known as mutual funds) come in three basic types: open-end, closed-end and unit investment trusts. A recent variation is the Exchange-Traded Fund (ETF).
Open-end funds are most convenient for long-term investors who make regular contributions to the fund. Open-end funds can economically process small investments and efficiently reinvest distributions, making them ideal for college saving and retirement accounts. Shares are purchased and redeemed directly from the company at net asset value (NAV). Some funds carry a sales charge (commission), but all funds impose management fees (expense ratios).
Closed-end funds and ETFs trade on stock exchanges and are purchased and sold just like shares of stock. While these types can be effective for long-term investors, they are also popular for shorter-term trading or hedging. A major risk (particularly for closed-end funds) is that they can trade at a significant premium to their NAV (ex: you could pay $1.10 for $1.00 worth of assets). Another problem can develop with thinly traded (illiquid) issues when your order causes a significant price fluctuation resulting in a poor execution. Investors pay a brokerage commission and a management fee.
Unit investment trusts are less common. They usually have fixed portfolios and trade infrequently (generally bought and sold out of broker/dealer inventories). They carry a commission and management fees.
Whichever you choose, read the prospectus to ensure that the fund’s investment objectives, strategy and risk profile match your own and that you know exactly what you will pay in sales charges and annual fund fees.