The 7 Main Types of Investment Companies (And How They Work)
Investing your money is one way to try and grow your wealth over time. But with so many investment options out there, it can be hard to know where to start. One popular route is to go through an investment company. These firms pool money from many investors and use it to purchase a variety of assets.
Here are 7 of the most common types of investment companies and how they work:
Mutual Funds – The Popular Player
Mutual funds are one of the most popular types of investment companies. They pool money from thousands of investors to buy stocks, bonds, and other securities. The fund manager oversees the portfolio and tries to generate returns that beat the market. With low minimum investments, mutual funds are accessible for many types of investors. They offer instant diversification and professional management.
Exchange-Traded Funds (ETFs) – The Indexers
Exchange-traded funds (ETFs) are similar to mutual funds but trade more like stocks. ETFs track various indexes, sectors, or assets, like the S&P 500. They offer low costs, tax efficiency, and stock-like features like limit orders and stop losses. While mutual funds price once per day, ETFs can be traded anytime the markets are open. This makes them flexible investment vehicles.
Closed-End Funds – The Discounted Play
Closed-end funds (CEFs) raise capital only once through an IPO. After that, shares trade on exchanges like stocks at prices set by supply and demand. This can allow CEF shares to trade at discounts or premiums to the actual net asset value of the underlying portfolio. Savvy investors can attempt to profit from these pricing discrepancies. CEFs offer professional management and use leverage to enhance income and returns.
Real Estate Investment Trusts (REITs) – The Property Lords
Real estate investment trusts (REITs) provide a way for individuals to invest in real estate without buying physical property. REITs purchase office buildings, apartments, hotels, storage units, and other real estate assets. To qualify as a REIT, the trust must pay out at least 90% of taxable income as shareholder dividends each year. This can result in attractive yields for investors. REITs offer the benefits of real estate with the liquidity of stocks.
Insurance Investment Companies – The Cash Reserves
Insurance investment companies are firms that offer annuities and other insurance products as investments. Annuities allow people to make contributions that grow tax-deferred. Payout options include lifetime income streams, death benefits for beneficiaries, and lump sum withdrawals. Insurance products often include riders and guarantees not found in other investments. These companies manage over $1.5 trillion in assets.
Business Development Companies (BDCs) – The Private Equity Partners
Business development companies (BDCs) operate like private equity or venture capital firms for individual investors. BDCs provide financing and consulting to small and medium-sized U.S. businesses. They offer access to a segment of the economy that is typically available only to institutional investors. BDCs must pay out 90% of taxable income as dividends, resulting in high yields. They also trade like regular stocks for added liquidity.
Hedge Funds – The Aggressive Tacticians
Hedge funds use alternative investment strategies like short selling, leverage, derivatives, and arbitrage. This allows them to pursue returns in any market environment. Hedge funds charge high fees and often have very high minimums, keeping them exclusive. The investor pools in hedge funds are typically only open to accredited and institutional investors. Hedge funds are aggressive and less regulated than many other investment company options.
With so many investment companies to choose from, investors can align their portfolios with their goals and risk tolerance. Working with a financial advisor can help navigate the pros and cons of each option. Do your due diligence before choosing an investment company to entrust with your hard-earned capital.
The Rising Popularity of Investment Companies Worldwide
Investment companies have seen increased global demand over the past decade as investors seek professional management and diversification. Total assets under management by mutual funds and ETFs have risen to $57.1 trillion globally as of 2020, up 140% from $23.8 trillion in 2011 according to the Investment Company Institute (ICI) Worldwide Mutual Fund Assets report. Developing regions like Asia and Latin America in particular have seen rapid growth.
Emerging Markets Lead the Charge
Emerging market mutual fund and ETF assets reached $3.1 trillion in 2020, more than quadrupling from $661 billion in 2005, reports the ICI. China has been the primary driver, with mutual fund assets soaring from $296 billion in 2005 to over $1.8 trillion by 2019. India has also seen assets climb from $25 billion to $334 billion. Other fast growing regions include Brazil, South Korea, and Taiwan. The expanding middle class and rising incomes in developing countries has fueled demand for investment vehicles.
Developed Nations Still Dominate
Despite faster growth rates in emerging markets, developed countries still hold the majority of global investment company assets. The U.S. leads with 44% market share or $25.5 trillion as of 2020. Europe comprised 28% with over $16 trillion in assets. Japan made up 7% with $4.1 trillion. By contrast, China represented only 5% and India less than 1% of world asset totals. But the gap is narrowing as developing nations continue gaining broader access to capital markets and investment products.
References:
https://www.sec.gov/answers/mfinvco.htm
https://www.sec.gov/investor/pubs/invclub.htm
https://www.ici.org/research/stats/worldwide/ww_12_31
https://www.ici.org/pdf/per25-01.pdf
https://www.ici.org/research/stats
Mutual Funds Definition & Example | InvestingAnswers
ETF Definition & Example | InvestingAnswers
Closed-End Fund (CEF) Definition & Example | InvestingAnswers
Real Estate Investment Trust (REIT) Definition & Example | InvestingAnswers
