What is an Investment Company?

An investment company is a company that invests pooled assets in securities. Some of the biggest financial services companies are investment companies. Major players them include Vanguard, Fidelity and Charles Schwab. Here’s how these companies operate and how they can work for you.

Mutual funds are the most common and familiar type of investment company. Like other types of investment companies, mutual funds collect money from investors. Then invest the combined capital into securities.

The securities owned by a mutual fund or other investment company are its portfolio. When an investor buys a share of an investment company, it represents part ownership of the portfolio.

If the values of the securities that make up the portfolio increase, so does the value of the shares held by investors. If the portfolio generates income through dividend or interest payments, investors receive a portion of that income.

Shares of investment companies such as mutual funds are part of most investment portfolios. That includes individual brokerage accounts as well as retirement accounts such as IRAs and company-sponsored 401(k) plans.

Some of the biggest financial services companies are investment companies. Major players among investment companies include Vanguard, Fidelity and Charles Schwab. The biggest investment companies oversee portfolios with assets worth trillions of dollars.

Investment companies offer investors a number of benefits compared to investing alone. For one thing, by combining funds from many individuals, investment companies are able to hire professional managers to select the securities to purchase.

Also, investment companies created a large quantity of money from pooled individual investments. As a result, investment companies can invest in many more companies and types of investments than the individuals could on their own. A single investment company may purchase stocks, bonds and other types of securities issued by hundreds or even thousands of companies in many different industries. This level of diversification helps reduce risk significantly.

The Securities and Exchange Commission (SEC) regulates and defines investment companies under the federal Investment Company Act of 1940. They are also subject to the federal securities acts passed in 1933 and 1934. These rules require, among other things, significant disclosure of the terms investors are agreeing to and the claims the investment company is making.

Most investment companies also provide other services in addition to investment management. Added services include holding securities as custodians for investors, keeping records, handling accounting, managing taxes and seeing to legal requirements.

In addition to mutual funds, the Investment Company Act of 1940 recognizes two other types of investment companies. These are closed-end funds and unit investment trusts. Here are differences among these three:

• Mutual funds are also called open-end funds. They issue a varying number of shares, so that when investors put money into the funds, they are issued new shares. Investors can sell shares back to the mutual funds at the net asset value (NAV), which also varies.
• Closed-end funds, sometimes referred to as investment trusts, sell a set number of shares in an initial public offering. When investors sell shares, they don’t sell them back to the funds. Instead, shares trade among investors on exchanges at a market-determined price that is a discount to the NAV. Many exchange-traded funds are closed-end funds.
• Unit investment trusts (UITs), which may be referred to as unit trusts, sell securities called units that represent shares in the trust’s assets. UIT units are redeemable, meaning investors can sell the back to the UIT at the NAV.

Under these three headings, there are many varieties of investment companies. These types include stock funds, bond funds, hybrid funds, money market funds, target funds and index funds.

Hedge funds are another investment vehicle that pools funds from many investors. However, with fewer than 100 investors, hedge funds fall short of the investment company designation under the 1940 act. That means, among other things that they don’t have the same disclosure requirements.

Investment companies are the most popular way for people to invest in the securities markets. They include mutual funds, closed-end funds and UITs. Regulations governing investment companies protect investors from misleading information and fraud. And by pooling their assets, investors get the benefits of diversification and professional management.

• Which investment company is right for you? A financial advisor may have some ideas. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
• Although hedge funds lack the same disclosure requirements as investment companies under the Investment Company Act of 1940, they still draw oversight to keep them from defrauding investors. Sophisticated investors who control significant personal wealth might consider hedge funds as an option.

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