The Importance of Investment Companies

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The world of investing is a complex, dynamic and volatile environment that can provide even the most seasoned investors with a lifetime of drama. For many casual investors, the term investment may be synonymous with retirement savings, mutual funds and a wide array of other popular catchphrases. However, a surprisingly large number of adults forego the research needed to thoroughly understand how these investments work and simply follow the status quo when it comes to placing their money in the marketplace. In the best case of scenarios, situations such as these still result in lucrative gains. However, in times of market turmoil, losses are difficult to avoid.

Tips

  • Investment companies actively manage the funds of investors around the world in order to ensure that the best possible returns are delivered throughout the year.

Assessing The Basics of Investment Companies

Although there is no true substitute for personal research, investment companies provide a stable platform that individuals can rely on to assist them with their strategies and ensure that their hard-earned funds are used strategically. For those individuals who simply do not have the time to track and manage their investments throughout the day, investment companies are absolutely indispensable. Understanding the benefits of these companies and the specific services they provide may help you determine the importance of funding an investment account and whether or not reaching out to an investment professional is in your best interest.

Broadly defined, the role of an investment company is to actively manage funds for members of the public they represent. General speaking, investment companies pool the funds they have collected from their clients and place them in a variety of different funds. Depending upon the scope of their investment, investors will share in the profit or loss of the funds at a rate that is proportional to their involvement. For example, an individual who has invested twice as much money as another individual in the fund will profit at twice the rate of this second investor.

Exploring Fund Offerings

Within an investment company, there are generally two types of funds offered to investors, those being closed and open-ended funds. Open-ended funds are by far one of the most common resources for casual investors. These funds are a type of mutual fund in which a seemingly limitless number of shares can be issued to investors. When shares are purchased by an investor, new shares are simultaneously created. Inversely, shares are taken out of the fund entirely when they are sold by investors. This helps ensure a degree of price stability and protects against any form of share diluting.

The price of these shares is directly related to their net asset value, or NAV. The NAV is typically calculated at the end of a trading session and reflects the current value of the securities that are incorporated into the fund. Given the fact that shares can be created and destroyed as part of the buying and selling process, it is important to note that they are not sold on the open market. This can also help explain why NAV calculations only occur at the end of the trading day rather than being updated in real time during a trading season. Given the larger number of individuals investing in these mutual funds, the role of mutual funds in the economy has grown tremendously over the past several decades.

Understanding Closed-End Funds

Unlike open-ended funds, the shares that are bought and sold are limited in scope and widely available in financial markets. When investment companies manage closed funds, the company itself is being publicly traded. The limited number of shares available in the fund are first sold through an initial public offering, or IPO, which helps raise valuable capital for the fund. Like an open-ended fund, the closed-end fund is also overseen by an investment manager.

Closed-end funds often experience a greater degree of volatility and liquidity due to the fact that shares in the fund – and, consequently, the investment company – can be bought and sold through financial markets throughout the trading session. Unlike the NAV calculations undertaken for open-ended funds, the price of shares in a closed-end fund will fluctuate throughout the trading day. Using a brokerage account, an individual can invest in one of these funds as they see fit.

Researching the Importance of Investment Companies

Ultimately, investors who choose to put their funds in either a closed-end or open-ended fund managed by an investment company are trusting the skills and expertise of the fund managers to help them generate wealth. Herein lies what is perhaps the primary importance of investment companies. Regardless of the current amount of capital you have to invest, you may discover that investment companies help you build your wealth at a rate of speed and with a degree of efficiency that you could not reasonably expect to accomplish on your own.

Granted, you will be paying for the expertise these companies provide. Investment companies list an expense ratio that represents the total portion of the fund's assets that will be used to cover their own administrative needs, including employee compensation. As could be expected, the more prestigious funds may charge higher expense ratios in anticipation of delivering a greater degree of profit to their clients.

While many individuals find that investment companies provide a much-needed service, others feel that they can confidently manage their investments on their own. Ultimately, this is a choice that each investor must make on their own. In times of market volatility, some investors may feel particularly chagrined if they entrusted their funds to an investment company that delivered staggering losses. Inversely, many investors adopting the DIY feel that they "missed the boat" when fund managers are able to deliver significant returns for their clients. Regardless of the outcome, however, there is no denying the important role that investment companies play in the modern wealth management marketplace today.

Choosing an Investment Company

The best way to learn more about the offerings of an investment company is simply to do your own research. The abundance of online resources available to investors today can help you explore the personnel working within a company, as well as their investment track record. It is important to explore a fund's history both in times of market boom and market bust. While statements boasting of substantial returns during a bull market may be thrilling, a far better measure of success is how these same investment companies faired during prolonged bear markets.

Taking Your First Steps

For those who are ready to dip their toes into the world of open-ended or closed-ended funds, a plausible first step could be to initiate a small deposit and evaluate how the fund manages the investment and reports on activity over an extended period. Transparency and performance are both important measures of legitimacy in an investment company. Investors should always ensure that the company they have enlisted to manage their wealth is keeping their interests as a priority.

It is also not uncommon for a variety of financial publications to list the top performing investment companies on an annual basis. This information can help y0u gain a broad understanding of current "winners" and "losers" in the investment marketplace. Whether or not these metrics inform your decision is up to you, but it certainly doesn't hurt to gather additional information that can further educate you on the intricate workings of this fast-paced niche of the financial marketplace.

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About the Author

Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community. Ryan's work has been featured at Zacks Investment Research, SFGate Home Guides, Bloomberg, HuffPost and more.