MUTUAL FUNDS and ETFS

A Guide for Investors

U.S. SECURITIES AND EXCHANGE COMMISSION | 1

Mutual Funds and ExchangeTraded Funds (ETFs)

American investors often turn to mutual funds and exchangetraded funds (ETFs) to save for retirement and other financial 

goals. Although mutual funds and ETFs have similarities, they 

have differences that may make one option preferable for any 

particular investor. This brochure explains the basics of mutual 

fund and ETF investing, how each investment option works, 

the potential costs associated with each option, and how to 

research a particular investment.

U.S. Securities and Exchange Commission

Office of Investor Education and Advocacy

100 F Street, NE

Washington, DC 20549-0213

Toll-free: (800) 732-0330

Website: www.Investor.gov
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Table of Contents

How Mutual Funds and ETFs Work . . . . . . . . . . . . . . . . . .4

How Mutual Funds Work ................................. 4

How ETFs Work .......................................... 6

Common Features of Mutual Funds and ETFs ............... 8

Factors to Consider . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Before Investing in Mutual Funds or ETFs .................. 11

Different Types of Mutual Funds and ETFs ................. 13

Different Types of Investment Strategies .................. 19

How Mutual Funds and ETFs Can Provide 

Returns to Investors ..................................... 22

Things That Could Reduce Mutual Funds’ and 

ETFs’ Returns ........................................... 24

Fees and Expenses ...................................... 24

Classes of Mutual Funds ................................. 33

Tax Consequences ...................................... 36

Sources of Information .................................. 37

Avoiding Common Pitfalls . . . . . . . . . . . . . . . . . . . . . . . . . . .41

Past Performance ....................................... 41

Looking Beyond a Mutual Fund or ETF Name .............. 42

Bank Products Versus Mutual Funds ...................... 42

If You Have a Question or Complaint . . . . . . . . . . . . . . . 44

Glossary of Key Mutual Fund 

and ETF Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
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Key Points to Remember

■■ Mutual funds and ETFs are not guaranteed or insured by 

the FDIC or any other government agency—even if you buy 

through a bank and the fund carries the bank’s name. You 

can lose money investing in mutual funds or ETFs.

■■ Past performance is not a reliable indicator of future performance, so don’t be dazzled by last year’s high returns. 

But past performance can help you assess a fund’s volatility 

over time.

■■ All mutual funds and ETFs have costs that lower your investment returns. Shop around and compare fees.
4 | MUTUAL FUNDS AND ETFS

How Mutual Funds and ETFs Work 

How Mutual Funds Work

A mutual fund is an SEC-registered open-end investment 

company that pools money from many investors and invests 

the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of 

these investments. The combined securities and assets the 

mutual fund owns are known as its portfolio, which is managed 

by an SEC-registered investment adviser. Each mutual fund 

share represents an investor’s proportionate ownership of the 

mutual fund’s portfolio and the income the portfolio generates. 

Investors in mutual funds buy their shares from, and sell/

redeem their shares to, the mutual funds themselves. Mutual 

fund shares are typically purchased from the fund directly or 

through investment professionals like brokers. Mutual funds 

are required by law to price their shares each business day and 

they typically do so after the major U.S. exchanges close. This 

price—the per-share value of the mutual fund’s assets minus 

its liabilities—is called the NAV or net asset value. Mutual funds 

must sell and redeem their shares at the NAV that is calculated 

after the investor places a purchase or redemption order. This 

means that, when an investor places a purchase order for 

mutual fund shares during the day, the investor won’t know 

what the purchase price is until the next NAV is calculated.
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Types of Investment Companies

There are three basic types of investment companies:

Open-end investment companies or open-end 

funds—which sell shares on a continuous basis, 

purchased from, and redeemed by, the fund (or 

through a broker for the fund);

Closed-end investment companies or closed-end 

funds—which sell a fixed number of shares at one 

time (in an initial public offering) that later trade on 

a secondary market; and 

Unit Investment Trusts (UITs)—which make a onetime public offering of only a specific, fixed number 

of redeemable securities called units and which will 

terminate and dissolve on a date that is specified at 

the time the UIT is created.

Mutual funds are open-end funds. ETFs are generally 

structured as open-end funds, but can also be structured as UITs. ETFs operate pursuant to SEC exemptive 

orders. 
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How ETFs Work

Like mutual funds, ETFs are SEC-registered investment companies that offer investors a way to pool their money in a fund 

that makes investments in stocks, bonds, other assets or some 

combination of these investments and, in return, to receive an 

interest in that investment pool. Unlike mutual funds, however, ETFs do not sell individual shares directly to, or redeem 

their individual shares directly from, retail investors. Instead, 

ETF shares are traded throughout the day on national stock 

exchanges and at market prices that may or may not be the 

same as the NAV of the shares. 

ETF sponsors enter into contractual relationships with one 

or more Authorized Participants—financial institutions which 

are typically large broker-dealers. Typically, only Authorized 

Participants purchase and redeem shares directly from the 

ETF. In addition, they can do so only in large blocks (e.g., 50,000 

ETF shares) commonly called creation units, and they typically 

“pay” for the creation units in an in-kind exchange with a group 

or basket of securities and other assets that generally mirrors 

the ETF’s portfolio. 

Once an Authorized Participant receives the block of ETF 

shares, the Authorized Participant may sell the ETF shares in 

the secondary market to investors. An ETF share is trading at 

a premium when its market price is higher than the value of 

its underlying holdings. An ETF share is trading at a discount 

when its market price is lower than the value of its underlying 

holdings. A history of the end-of-day premiums and discounts 

that an ETF experiences—i.e., its NAV per share compared to 

its closing market price per share—can usually be found on 

the website of the ETF or its sponsor. Like a mutual fund, an 

ETF must calculate its NAV at least once every day. 
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A Word about Exchange-Traded Products (ETPs)

ETFs are just one type of investment within a broader 

category of financial products called exchange-traded products (ETPs). ETPs constitute a diverse class 

of financial products that seek to provide investors 

with exposure to financial instruments, financial 

benchmarks, or investment strategies across a wide 

range of asset classes. ETP trading occurs on national 

securities exchanges and other secondary markets, 

making ETPs widely available to market participants 

including individual investors.

Other types of ETPs include exchange-traded 

commodity funds and exchange-traded notes (ETNs). 

Exchange-traded commodity funds are structured as 

trusts or partnerships that physically hold a precious 

metal or that hold a portfolio of futures or other 

derivatives contracts on certain commodities or currencies. ETNs are secured debt obligations of financial institutions that trade on a securities exchange. 

ETN payment terms are linked to the performance 

of a reference index or benchmark, representing 

the ETN’s investment objective. ETNs are complex, 

involve many risks for interested investors, and can 

result in the loss of the entire investment.

This brochure discusses only ETFs that are registered as open-end investment companies or unit 

investment trusts under the Investment Company 

Act of 1940. It does not address other types of ETPs, 

such as exchange-traded commodity funds or ETNs.
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Common Features of Mutual Funds and ETFs

Some common features of mutual funds and ETFs are 

described below. Whether any particular feature is an advantage or disadvantage for you will depend on your unique 

circumstances—always be sure that the investment you are 

considering has the features that are important to you. 

■■ Professional Management. Most funds and ETFs are 

managed by investment advisers who are registered with 

the SEC.

■■ 	Diversification. Spreading investments across a wide range 

of companies or industry sectors can help lower risk if a 

company or sector fails. Many investors find it less expensive to achieve such diversification through ownership of 

certain mutual funds or certain ETFs than through ownership of individual stocks or bonds.

■■ Low Minimum Investment. Some mutual funds accommodate investors who don’t have a lot of money to invest by 

setting relatively low dollar amounts for the initial purchase, 

subsequent monthly purchases, or both. Similarly, ETF 

shares can often be purchased on the market for relatively 

low dollar amounts. 
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■ Liquidity and Trading Convenience. Mutual fund 

investors can readily redeem their shares at the next 

calculated NAV—minus any fees and charges assessed on 

redemption—on any business day. Mutual funds must send 

investors payment for the shares within seven days, but 

many funds provide payment sooner. ETF investors can 

trade their shares on the market at any time the market is 

open at the market price—minus any fees and charges 

incurred at the time of sale. ETF and mutual fund shares

traded through a broker are required to settle in two

business days.

■ Costs Despite Negative Returns. Investors in mutual funds

must pay sales charges, annual fees, management fees and

other expenses (discussed on pages 24–32), regardless of

how the mutual fund performs. Investors may also have to

pay taxes on any capital gains distribution they receive.

Investors in ETFs must pay brokerage commissions, annual

fees, management fees and other expenses (discussed on

pages 24–32), regardless of how the ETF performs. ETF

investors may also have to pay taxes on any capital gains

distributions; however, because of the structure of certain

ETFs that redeem proceeds in kind, taxes on ETF investments 

have historically been lower than those for mutual fund 

investments. It is important to note that the tax efficiency of 

ETFs is not relevant if an investor holds the mutual fund or 

ETF investment in a tax-advantaged account, such as an IRA 

or a 401(k). 
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■■ Lack of Control. Investors in both mutual funds and ETFs 

cannot directly influence which securities are included in the 

funds’ portfolios.

■■ Potential Price Uncertainty. With an individual stock or an 

ETF, an investor can obtain real-time (or close to real-time) 

pricing information with relative ease by checking financial 

websites or by calling a broker. By contrast, with a mutual 

fund, the price at which an investor purchases or redeems 

shares will depend on the fund’s NAV, which the fund might 

not calculate until many hours after an order has been 

placed. 
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Factors to Consider

Before Investing in Mutual Funds or ETFs: 

■■ 	Determine	your	financial	goals	and	risk	tolerance. When 

it comes to investing in mutual funds and ETFs, investors 

have thousands of choices. Before you invest in any mutual 

fund or ETF, you must decide whether the investment strategy and risks are a good fit for you. You should also consider more generally whether the unique style of investing of 

the mutual fund’s or ETF’s sponsor is a good fit for you. The 

first step to successful investing is to figure out your current 

financial goals and risk tolerance—either on your own or 

with the help of an investment professional. 

■■ Beware of risk. All investments carry some level of risk. 

An investor can lose some or all of the money he or she 

invests—the principal—because securities held by a fund go 

up and down in value. Dividend payments may also fluctuate as market conditions change. Mutual funds and ETFs 

have different risks and rewards. Generally, the higher the 

potential return, the higher the risk of loss. 

■■ Consider the sponsor’s investing style. Before you invest, 

you may want to research the sponsor of the mutual fund 

or ETF you are considering. The sponsor’s website is often 

a good place to begin, and it is helpful to spend some time 

browsing through the website to get a better understanding 

of the sponsor’s underlying philosophy on investing. Each 
12 | MUTUAL FUNDS AND ETFS

sponsor has its own style of investing that will affect how it 

manages its mutual funds and ETFs. It is helpful to understand each sponsor’s style of investing, so you can better 

choose the right investment for you.

■■ Ask and check. Before you engage an investment professional or purchase shares of a mutual fund or ETF, make 

sure you research and verify relevant information to determine which option is best suited for you. 

• Investment professionals: Details on an investment 

professional’s background and qualifications are available on the SEC’s Investment Adviser Public Disclosure 

(IAPD) website (www.adviserinfo.sec.gov/) or on the 

SEC’s website for individual investors, Investor.gov. 

If you have any questions about checking the background of an investment professional, you can call 

the SEC’s toll-free investor assistance line at (800) 

732-0330 for help.

• Mutual funds and ETFs: You can research a mutual fund 

or ETF by reading its prospectus (discussed on pages 

37-39) carefully to learn about its investment strategy 

and the potential risks. You can find the prospectus on 

the mutual fund’s or ETF’s website or on the SEC’s EDGAR 

database (www.sec.gov/edgar/searchedgar/mutualsearch.html) and download the documents for free. 
U.S. SECURITIES AND EXCHANGE COMMISSION | 13

A Word about Derivatives

Derivatives are financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security, or index. Even 

small market movements can dramatically affect their 

value, sometimes in unpredictable ways.

There are many types of derivatives with many 

different uses. A mutual fund’s or ETF’s prospectus will 

disclose whether and how it may use derivatives. An 

investor may also want to call a fund and ask how it 

uses these instruments.

Different Types of Mutual Funds and ETFs

Mutual funds and ETFs fall into several main categories. Some 

are bond funds (also called fixed income funds), and some are 

stock funds (also called equity funds). There are also funds that 

invest in a combination of these categories, such as balanced 

funds and target date funds, and newer types of funds such 

as alternative funds, smart-beta funds and esoteric ETFs. In 

addition, there are money market funds, which are a specific 

type of mutual fund. 

■■Bond Funds 

Bond funds invest primarily in bonds or other types of debt 

securities. They generally have higher risks than money 

market funds (discussed on pages 18-19), largely because 
14 | MUTUAL FUNDS AND ETFS

they typically pursue strategies aimed at producing higher 

yields. Unlike money market funds, the SEC’s rules do not 

restrict bond funds to high-quality or short-term investments. 

Because there are many different types of bonds, bond funds 

can vary dramatically in their risks and rewards. 

Some of the risks associated with bond funds include: 

• Credit Risk—the possibility that companies or other 

issuers whose bonds are owned by the fund may fail to 

pay their debts (including the debt owed to holders of 

their bonds). Credit risk is less of a factor for bond funds 

that invest in insured bonds or U.S. Treasury Bonds. By 

contrast, those that invest in the bonds of companies 

with poor credit ratings generally will be subject to 

higher risk; 

• Interest Rate Risk—the risk that the market value of the 

bonds will go down when interest rates go up. Because 

of this, an investor can lose money in any bond fund, 

including those that invest only in insured bonds or U.S. 

Treasury Bonds. Funds that invest in longer-term bonds 

tend to have higher interest rate risk; and,

• Prepayment Risk—the chance that a bond will be paid 

off early. For example, if interest rates fall, a bond issuer 

may decide to pay off (or retire) its debt and issue new 

bonds that pay a lower rate. When this happens, the 

fund may not be able to reinvest the proceeds in an 

investment with as high a return or yield.
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■ Stock Funds

Stock funds invest primarily in stocks, which are also known as 

equities. Although a stock fund’s value can rise and fall quickly 

(and dramatically) over the short term, historically, stocks 

have performed better over the long term than other types of 

investments—including corporate bonds, government bonds, 

and treasury securities. 

Stock funds can be subject to various investment risks, 

including Market Risk, which poses the greatest potential 

danger for investors in stock funds. Stock prices can fluctuate 

for a broad range of reasons—such as the overall strength of 

the economy or demand for particular products or services.

■ Balanced Funds

Balanced funds invest in stocks and bonds and sometimes 

money market instruments in an attempt to reduce risk but 

still provide capital appreciation and income. They are also 

known as asset allocation funds and typically hold a relatively 

fixed allocation of the categories of portfolio instruments. But 

the allocation will differ from balanced fund to balanced fund. 

These funds are designed to reduce risk by diversifying among 

investment categories, but they still share the same risks that 

are associated with the underlying types of instruments.

■ Target Date Funds

Also called target date retirement funds or lifecycle funds, 

these funds also invest in stocks, bonds, and other investments. Target date funds are designed to be long-term investments for individuals with particular retirement dates in mind. 

The name of the fund often refers to its target retirement date 
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or target date. For example, there are funds with names such 

as “Portfolio 2050,” “Retirement Fund 2050,” or “Target 2050” 

that are designed for individuals who intend to retire in or near 

the year 2050. Most target date funds are designed so that the 

fund’s allocation of investments will automatically change over 

time in a way that is intended to become more conservative 

as the target date approaches. That means that funds typically 

shift over time from a mix with a lot of stock investments in the 

beginning to a mix weighted more toward bonds. 

Even if they share the same target date, target date funds 

may have very different investment strategies and risks and 

the timing of their allocation changes may be different. They 

also may have different investment results and may charge 

different fees. Often a target date fund invests in other funds, 

and fees may be charged by both the target date fund and the 

other funds. In addition, target date funds do not guarantee 

that an investor will have sufficient retirement income at the 

target date, and investors can lose money. Target date funds 

are generally associated with the same risks as the underlying 

investments.

■ Alternative Funds 

Alternative funds are funds that invest in alternative investments such as non-traditional asset classes (e.g., global 

real estate or currencies) and illiquid assets (e.g., private 

debt) and/or employ non-traditional trading strategies (e.g., 

selling short). They are sometimes called “hedge funds for 

the masses” because they are a way to get hedge fund-like 

exposure in a registered fund. These funds generally seek 

to produce positive returns that are not closely correlated to 

traditional investments or benchmarks. Many investors may 
U.S. SECURITIES AND EXCHANGE COMMISSION | 17

see alternative funds as a way to diversify their portfolios while 

retaining liquidity. The risks associated with these investments 

vary depending on the assets and trading strategies employed. 

These funds can employ complicated investment strategies, 

and their fees and expenses are commonly higher than traditionally managed funds. In addition, these types of funds 

generally have limited performance histories, and it is unclear 

how they will perform in periods of market stress. 

■ Smart-Beta Funds

These funds are index funds (discussed below) with a twist. 

They compose their index by ranking stock using preset factors 

relating to risk and return, such as growth or value, and not 

simply by market capitalization as most traditional index funds 

do. They aim to achieve better returns than traditional index 

funds, but at a lower cost than active funds. These funds 

can be more complicated and have higher expenses than 

traditional index funds, and the factors are sometimes based 

on hypothetical, backward-looking returns. In addition, 

these types of funds generally have limited performance 

histories, and it is unclear how they will perform in periods 

of market stress. 

■ Esoteric ETFs

Esoteric or exotic funds are ETFs that focus on niche investments or narrowly focused strategies. They may be complicated investments and may have higher expenses. In addition, 

these ETFs are often thinly traded, which means they can be 

harder to sell and may have larger bid-ask spreads (discussed 

on page 28-29) than ETFs that aren’t as thinly traded. 
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A Word about Hedge Funds

Hedge fund is a general, non-legal term used to 

describe private, unregistered investment pools 

that traditionally have been limited to sophisticated, 

wealthy investors. Hedge funds are not mutual funds 

and, as such, are not subject to the numerous regulations that apply to mutual funds for the protection of 

investors—including regulations requiring that mutual 

fund shares be redeemable at any time, regulations 

protecting against conflicts of interest, regulations to 

assure fairness in the pricing of fund shares, disclosure 

regulations, regulations limiting the use of leverage, 

and more.

■ Money Market Funds 

Money market funds are a type of mutual fund that has 

relatively low risks compared to other mutual funds and ETFs 

(and most other investments). By law, they can invest in only 

certain high-quality, short-term investments issued by the U.S. 

Government, U.S. corporations, and state and local governments. Government and retail money market funds try to keep 

their NAV at a stable $1.00 per share, but the NAV may fall 

below $1.00 if the fund’s investments perform poorly. Investor 

losses have been rare, but they are possible. 

• A Government Money Market Fund is a money market 

fund that invests 99.5% or more of its total assets in 

cash, government securities and/or repurchase agreements that are collateralized solely by government 

securities or cash. 
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• A Retail Money Market Fund is a money market fund 

that has policies and procedures reasonably designed 

to limit all beneficial owners of the money market 

fund to natural persons. 

Other money market funds, however, have a floating NAV like 

other mutual funds that fluctuates along with changes in the 

market-based value of their portfolio securities. 

All money market funds pay dividends that generally 

reflect short-term interest rates, and historically the returns 

for money market funds have been lower than for either bond 

or stock funds. A risk commonly associated with money market funds is Inflation Risk, which is the risk that inflation will 

outpace and erode investment returns over time.

Different Types of Investment Strategies 

■■Index-based Funds 

Index-based mutual funds and ETFs seek to track an underlying securities index and achieve returns that closely correspond to the returns of that index with low fees. They generally 

invest primarily in the component securities of the index and 

typically have lower management fees than actively managed 

funds. Some index funds may also use derivatives (such as 

options or futures) to help achieve their investment objective. Index-based funds with seemingly similar benchmarks 

can actually be quite different and can deliver very different 

returns. For example, some index funds invest in all of the 

companies included in an index; other index funds invest in a 

representative sample of the companies included in an index. 

Because an index fund tracks the securities on a particular 

index, it may have less flexibility than a non-index fund to react 

to price declines in the securities contained in the index. Also 
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because market indexes themselves have no expenses, even a 

passively managed index fund can underperform its index due 

to fees and taxes.

■ Actively Managed Funds

The adviser of an actively managed mutual fund or ETF may 

buy or sell components in the portfolio on a daily basis without 

regard to conformity with an index, provided that the trades 

are consistent with the overall investment objective of the 

fund. Unlike similar mutual funds, actively managed ETFs are 

required to publish their holdings daily. Because there is no 

underlying index that can serve as a point of reference for 

investors and other market participants as to the ETF’s holdings, disclosing the specific fund holdings ensures that market 

participants have sufficient information to engage in activity, 

called arbitrage, that works to keep the market price of ETF 

shares closely linked to the ETF’s underlying value. 

■ Leveraged, inverse and inverse leveraged ETFs 

Leveraged, inverse, and inverse leveraged ETFs seek to achieve 

a daily return that is a multiple or inverse multiple of the daily 

return of a securities index. These ETFs are a subset of indexbased ETFs because they track a securities index. They seek 

to achieve their stated objectives on a daily basis. Investors 

should be aware that the performance of these ETFs over a 

period longer than one day will probably differ significantly 

from their stated daily performance objectives. These ETFs 

often employ techniques such as engaging in short sales and 

using swaps, futures contracts and other derivatives that can 

expose the ETF, and by extension the ETF investors, to a host 

of risks. As such, these are specialized products that typically are 

not suitable for buy-and-hold investors.
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A Word on Active and Passive Investing

An active investment strategy relies on the skill of an 

investment manager to construct and manage the portfolio of a fund in an effort to provide exposure to certain 

types of investments or outperform an investment 

benchmark or index. An actively managed fund has 

the potential to outperform the market, but its performance is dependent on the skill of the manager. Also, 

actively managed funds historically have had higher 

management fees, which can significantly lower investment returns. The shareholder is paying for more active 

management of portfolio assets, which often leads to 

higher turnover costs in the portfolio and potentially 

negative federal income tax consequences. 

Passive investing is an investment strategy that is 

designed to achieve approximately the same return as 

a particular market index, before fees. The strategy can 

be implemented by replication—purchasing 100% of 

the securities in the same proportion as in the index or 

benchmark—or by a representative sampling of stocks 

in the index. Passive investing also typically comes with 

lower management fees. As discussed above, passively 

managed mutual funds are typically called index funds. 

Most ETFs are also passively managed, although 

there are some actively managed ETFs on the market. 

Passively managed ETFs typically have lower costs for 

the same reasons index mutual funds do. In addition, 

index-based ETFs’ costs and taxes can be even lower 

than index mutual funds’ because of the manner in 

which ETFs operate. 
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How Mutual Funds and ETFs Can 

Provide Returns to Investors 

Investors can make money from their investments in 

three ways: 

1. Dividend Payments—Depending on the underlying securities, a mutual fund or ETF may earn income in the form of 

dividends on the securities in its portfolio. The mutual fund or 

ETF then pays its shareholders nearly all of the income (minus 

disclosed expenses) it has earned.

2. Capital Gains Distributions—The price of the securities a 

mutual fund or ETF owns may increase. When a mutual fund 

or ETF sells a security that has increased in price, the mutual 

fund or ETF has a capital gain. At the end of the year, most 

mutual funds and ETFs distribute these capital gains (minus 

any capital losses) to shareholders. ETFs seek to minimize 

these capital gains by making in-kind exchanges to redeeming 

Authorized Participants instead of selling portfolio securities. 

3. Increased NAV/Increased Market Price—If the market 

value of a mutual fund’s portfolio increases, after deduction of 

expenses and liabilities, then the net asset value of the mutual 

fund and its shares increases. If the market value of an ETF’s 

portfolio increases, after deduction of expenses and liabilities, 

then the net asset value of the ETF increases, and the market 

price of its shares may also increase.

With respect to dividend payments and capital gains 

distributions, mutual funds usually will give investors a choice: 

the mutual fund can send the investor a check or other 

form of payment, or the investor can have the dividends or 
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A Word about 

Exchange-Traded Managed Funds (ETMF)

An exchange-traded managed fund (ETMF) is a 

new kind of registered investment company that 

is a hybrid between traditional mutual funds and 

exchange-traded funds. Like ETFs, ETMFs list and 

trade on a national exchange, directly issue and 

redeem shares only in creation units, and primarily 

use in-kind transfers of the basket of portfolio securities in issuing and redeeming creation units. Like 

mutual funds, ETMFs are bought and sold at prices 

linked to NAV and disclose their portfolio holdings 

quarterly with a 60-day delay. This structure may 

allow the product to provide certain cost and tax 

efficiencies of ETFs while maintaining the confidentiality of the current holdings similar to mutual funds. 

By not having to disclose their holdings on a daily 

basis as ETFs do, ETMFs may have an advantage in 

trying to outperform their benchmarks over time 

because they are less susceptible to front running 

by other investors who would be able to trade on 

the holdings’ disclosures. 

distributions reinvested in the mutual fund to buy more shares 

(often without paying an additional sales load). If an ETF investor wants to reinvest a dividend payment or capital gains distribution, the process can be more complicated and the investor 

may have to pay additional brokerage commissions. Investors 

should check with their ETF or investment professional.
24 | MUTUAL FUNDS AND ETFS

Things That Could Reduce 

Mutual Funds’ and ETFs’ Returns 

Investors should consider the effect that fees, expenses, and 

taxes will have on their returns over time. They can significantly reduce the returns on mutual funds and ETFs. 

Fees and Expenses 

As with any business, running a mutual fund or ETF involves 

costs. Funds pass along these costs to investors by imposing 

fees and expenses.

Shareholder fees are fees charged directly to mutual fund 

investors in connection with transactions such as buying, selling, or exchanging shares, or on a periodic basis with respect 

to account fees. An investor can find these fees and charges 

listed in the “Fee Table” section of a mutual fund’s prospectus 

or summary prospectus under the heading, “Shareholder 

Fees.” ETFs don’t charge these fees directly to investors, but 

they may have several types of transaction fees and costs, 

which are described below. 

Operating expenses are ongoing mutual fund and ETF costs 

such as investment advisory fees for managing the fund’s 

holdings, marketing and distribution expenses, as well as custodial, transfer agency, legal, and accountant’s fees. Operating 

expenses are regular and recurring fund-wide expenses that 

are typically paid out of fund assets, which means that investors indirectly pay these costs. These expenses are identified in 
U.S. SECURITIES AND EXCHANGE COMMISSION | 25

the “Fee Table” section of a mutual fund’s or ETF’s prospectus 

or summary prospectus under the heading, “Annual Fund 

Operating Expenses.” Although these fees and expenses may 

not be listed individually as specific line items on an account 

statement, they can have a substantial impact on an investment over time. 

Fees and expenses vary from fund to fund. If the funds are 

otherwise the same, a fund with lower fees will outperform 

a fund with higher fees. Remember, the more investors pay 

in fees and expenses, the less money they will have in their 

investment portfolio. As noted above, index funds typically 

have lower fees than actively managed funds.
26 | MUTUAL FUNDS AND ETFS

PROSPECTUS FEE TABLE

The following discussion details the disclosure required in the 

fee table in a mutual fund or ETF prospectus. ETFs don’t charge 

shareholder fees (that are required to be included in the fee 

table) directly to investors. But, they may have several types of 

transaction fees and costs which are also described below.

Fee Table: Shareholder Fees for mutual funds 

(fees paid directly from an investment)

■■ Sales Charge (Load) on Purchases—a fee some mutual 

funds charge investors when they buy shares, also known as a 

front-end load. This fee is typically paid to the broker that sells 

the mutual fund’s shares. In this respect, a sales load is like 

a commission investors pay when they purchase any type of 

security (like a stock or an ETF) from a broker. Front-end loads 

reduce the amount of an investment. For example, let’s say 

an investor has $1,000 and wants to invest it in a mutual fund 

with a 5% front-end load. The $50 sales load the investor must 

pay comes off the top of the investment leaving the remaining 

$950 to be invested in the mutual fund. 

■ Purchase Fee—a fee some mutual funds charge investors 

when they buy shares. Unlike a front-end sales load, a purchase fee is paid into fund assets (not to a broker) and is typically imposed to defray some of the mutual fund’s costs associated with the purchase. This fee is often imposed by a mutual 

fund that has high transaction costs, for example, because of 

its investment strategy. The fee is designed so that the other 

investors’ investments in the mutual fund are not diminished 

by the transaction costs of the purchase. Like front-end sales 

loads, purchase fees reduce the amount of the investment.
U.S. SECURITIES AND EXCHANGE COMMISSION | 27

■ Deferred Sales Charge (Load)—a fee some mutual funds 

charge investors when they sell or redeem their shares, also 

known as a back-end load. This fee is typically paid to the 

broker that sells the mutual fund’s shares. The most common 

type of back-end sales load is the contingent deferred sales 

load (also known as the CDSC or CDSL). The amount of this 

type of sales load will depend on how long the investor holds 

his or her shares. It typically decreases to zero if the investor 

holds his or her shares for a specified time period. When an 

investor purchases shares that are subject to a back-end sales 

load rather than a front-end sales load, no sales load is deducted at purchase, and all of the investors’ money is immediately 

used to purchase fund shares (assuming that no other fees or 

charges apply at the time of purchase). However, a back-end 

sales load will reduce an investor’s return on the investment. 

Typically, a fund calculates the amount of a back-end sales 

load based on the lesser of the value of the investor’s initial 

investment or the value of the investment at redemption. 

■ Redemption Fee—a fee some mutual funds charge investors when they sell or redeem their shares within a certain 

time frame of purchasing the shares. Unlike a deferred sales 

load, a redemption fee is paid into fund assets (not to the 

broker) and is typically used to defray fund costs associated 

with an investor’s redemption. The SEC limits redemption 

fees to 2%. 

■ Exchange Fee—a fee some mutual funds charge investors 

when they exchange (transfer) their investment to another 

fund within the same fund group or family of funds. 
28 | MUTUAL FUNDS AND ETFS

■■Account Fee—a fee some mutual funds charge investors 

in connection with the maintenance of their accounts. For 

example, some funds impose an account maintenance fee on 

accounts whose value is less than a certain dollar amount.

Transaction fees and costs for 

ETFs	not	reflected	in	the	Fee	Table	

■■Brokerage Commissions—ETF investors typically pay their 

brokers sales commissions with each purchase or sale of ETF 

shares, although some ETFs may be available commission-free. 

In this respect, a commission is like a sales load investors pay 

when purchasing or redeeming a mutual fund. Like front-end 

sales loads, brokerage commissions on a purchase reduce the 

amount of the investment. Like back-end sales loads, brokerage commissions on a sale reduce an investor’s return on the 

investment. A brokerage commission may be structured as a 

flat fee charged every time an investor trades. With a flat fee, 

the smaller the amount traded, the larger the percentage cost 

per trade is. Investors should consider the fee structure of a 

commission when purchasing or selling ETF shares. Check 

with your broker regarding these fees. Brokers should provide 

written notice to customers of these charges when accounts 

are opened and when any of the charges change.

■ Bid-ask spread—ETFs and other securities that trade on 

a securities market actually have two market prices—the bid 

price and the ask price. The term bid refers to the highest price 

a buyer will pay to buy a specified number of ETF shares at any 

given time. The term ask refers to the lowest price at which a 

seller will sell the ETF shares. The bid price will be lower than 
U.S. SECURITIES AND EXCHANGE COMMISSION | 29

the ask price and the difference between two prices is called 

the spread. An example is an ETF share that is trading for 

$59.50/$60. The bid price is $59.50, the ask price is $60.00, 

and the spread is 50 cents. If an investor buys 200 ETF shares 

at the ask price of $60 and sells them immediately at the bid 

price of $59.50, the investor would incur a loss of $100. This 

example demonstrates the impact of the spread on an ETF 

investment. ETFs that are more liquid and have higher trading 

volume have tighter or smaller spreads. The spread can be 

thought of as a hidden cost to investors since spreads reduce 

potential returns.

■ Changes in discounts and premiums to NAV—For a 

variety of reasons, an ETF’s market price may reflect a 

premium or a discount to the ETF’s underlying value or NAV. 

This is a potential cost but also a potential gain. An ETF share 

is trading at a premium when its market price is higher than 

the NAV or the value of its underlying holdings. An ETF share 

is trading at a discount when its market price is lower than 

the NAV or value of its underlying holdings. An investor may, 

therefore, pay more or less than the NAV when buying shares 

or receive more or less than NAV when selling shares.
30 | MUTUAL FUNDS AND ETFS

A Word about Exchanging Shares

A family of funds is a group of mutual funds that 

share administrative and distribution systems. Each 

fund in a family may have different investment objectives and follow different strategies.

Some funds offer exchange privileges within a 

family of funds, allowing shareholders to directly 

transfer their holdings from one fund to another as 

their investment goals or tolerance for risk change. 

While some funds impose fees for exchanges, 

most funds typically do not. To learn more about 

a fund’s exchange policies, call the fund’s toll-free 

number, visit its website, or read the “Shareholder 

Information” section of the prospectus.

Bear in mind that exchanges have tax consequences. Even if the fund doesn’t charge for the 

transfer, the investor will be liable for any capital 

gain on the sale of the old shares or, depending 

on the circumstances, eligible to take a capital loss 

(taxes are discussed generally on pages 36-37).
U.S. SECURITIES AND EXCHANGE COMMISSION | 31

Fee Table: Annual Fund Operating Expenses

(annual expenses paid as a percentage of the 

value of an investment)

■ Management Fees—fees paid out of mutual fund or ETF 

assets to the fund’s investment adviser for investment portfolio management. They can also include any other management fees payable to the fund’s investment adviser or its 

affiliates and administrative fees payable to the investment 

adviser that are not included in the Other Expenses category 

(discussed below).

■ Distribution [and/or Service] (12b-1) Fees—fees paid out 

of mutual fund or ETF assets to cover the costs of distribution 

(e.g., marketing and selling fund shares) and sometimes to 

cover the costs of providing shareholder services. Distribution 

Fees include fees to compensate brokers and others who sell 

fund shares and to pay for advertising, the printing and mailing 

of prospectuses to new investors, and the printing and mailing 

of sales literature. Shareholder Service Fees are fees paid to 

persons to respond to investor inquiries and provide investors 

with information about their investments. Shareholder service 

fees can be paid outside of 12b-1 fees, and if they are, they are 

included in the Other Expenses category (discussed below). 

■ Other Expenses—fees paid out of mutual fund or ETF 

assets that are not already included under Management Fees 

or Distribution or Service (12b-1) Fees (such as any shareholder service expenses that are not already included in the 12b-1 

fees), custodial expenses, legal and account expenses, transfer 

agent expenses and other administrative expenses.
32 | MUTUAL FUNDS AND ETFS

■■ Total Annual Fund Operating Expenses (Expense 

Ratio)—the line of the fee table that represents the total of 

a mutual fund’s or ETF’s annual fund operating expenses, 

expressed as a percentage of the fund’s average net assets. 

Looking at the expense ratio can help investors make comparisons among various mutual funds and ETFs.

Investors should be sure to review carefully the fee tables 

of any mutual funds or ETFs they’re considering, including 

no-load mutual funds. Even small differences in fees can 

translate into large differences in returns over time. For 

example, if an investor invested $10,000 in a fund that 

produced a 5% annual return before expenses and had 

annual operating expenses of 1.5%, then after 20 years the 

investor could have roughly $19,612. But if the fund had 

expenses of only 0.5%, then the investor would end up with 

$24,002—a 23% difference. 

A Word about No-Load Mutual Funds

Some mutual funds call themselves no-load. As the 

name implies, this means that the mutual fund does 

not charge any type of sales load. But, as discussed 

above, not every type of shareholder fee is a sales 

load. A no-load fund may charge direct fees that are 

not sales loads, such as purchase fees, redemption 

fees, exchange fees, and account fees. No-load 

funds also will have annual fund operating expenses 

that investors pay for indirectly through fund assets. 
U.S. SECURITIES AND EXCHANGE COMMISSION | 33

Classes of Mutual Funds 

Although ETFs offer only one class of shares, many mutual 

funds offer more than one class of shares. Each class will 

invest in the same portfolio of securities and will have the 

same investment objectives and policies. But each class 

will have different shareholder services and/or distribution 

arrangements with different fees and expenses. Because of 

the different fees and expenses, each class will likely have 

different performance results. A multi-class structure offers 

investors the ability to select a fee and expense structure that 

is most appropriate for their investment goals (including the 

time that they expect to remain invested in the fund). Here are 

some key characteristics of the most common mutual fund 

share classes offered to individual investors:

■ Class A Shares—Class A shares typically charge a front-end 

sales load, but they tend to have a lower 12b-1 fee and lower 

annual expenses than other mutual fund share classes. Some 

mutual funds reduce the front-end load as the size of the 

investment increases. These discounts are called breakpoints 

(discussed below).

■ Class B Shares—Class B shares typically do not have a frontend sales load. Instead, they may charge a contingent deferred 

sales load and a 12b-1 fee (along with other annual expenses). 

Typically the amount of the contingent deferred sales load decreases the longer an investor holds the shares. Class B shares 

also might convert automatically to a class with a lower 12b-1 

fee and no contingent deferred sales load if the investor holds 

the shares long enough. 
34 | MUTUAL FUNDS AND ETFS

■ Class C Shares—Class C shares might have a 12b-1 fee, other annual expenses, and either a front-end or back-end sales 

load. But the front-end or back-end load for Class C shares 

tends to be lower than for Class A or Class B shares, respectively. Unlike Class B shares, Class C shares generally do not 

convert to another class; as a result, the back-end load will not 

decrease over time. Class C shares tend to have higher annual 

expenses than either Class A or Class B shares.

■ Other Classes—Other classes may also exist for some funds.
U.S. SECURITIES AND EXCHANGE COMMISSION | 35

A Word about Breakpoints

Some mutual funds that charge front-end sales 

loads will charge lower sales loads for larger investments. In the prospectus fee table, they are referred 

to as sales charge discounts, but the investment 

levels required to obtain a reduced sales load are 

more commonly referred to as breakpoints.

The SEC does not require a mutual fund to offer 

breakpoints in its sales load. But, if the mutual fund 

offers breakpoints, the mutual fund must disclose 

them and brokers must apply them. In addition, 

a brokerage firm is not allowed to sell shares of a 

mutual fund in an amount that is just below the 

mutual fund’s breakpoint simply to earn a higher 

commission.

Each fund company establishes its own formula 

for how it will calculate whether an investor is 

entitled to receive a breakpoint. For that reason, it is 

important for investors to seek out breakpoint information from their financial advisors or the mutual 

fund itself. An investor will need to ask how a particular mutual fund establishes eligibility for breakpoint discounts, as well as what the mutual fund’s 

breakpoint amounts are. Some of this information 

is also included in the “Fee Table” section of the 

mutual fund’s prospectus or summary prospectus.
36 | MUTUAL FUNDS AND ETFS

Tax Consequences

When an investor buys and holds an individual stock or bond, 

the investor must pay income tax each year on the dividends 

or interest received. But the investor won’t have to pay any 

capital gains tax until he or she actually sells and unless he 

or she makes a profit. Mutual funds and ETFs are somewhat 

different. 

As with an individual stock, when an investor buys and 

holds mutual fund or ETF shares the investor will owe income 

tax each year on any dividends received. In addition, the investor will also owe taxes on any personal capital gains in years

when an investor sells shares. 

However, unlike with an individual stock, an investor may 

also have to pay taxes each year on the mutual fund’s or ETF’s 

capital gains even if the mutual fund or ETF has had a negative 

return and the investor hasn’t sold any shares. That’s because 

the law requires mutual funds and ETFs to distribute any net 

capital gains on the sale of portfolio securities to shareholders. 

ETFs are typically more tax efficient in this regard than mutual 

funds because ETF shares are frequently redeemed in-kind 

by the Authorized Participants. This means that an ETF may 

deliver specified portfolio securities to Authorized Participants 

who are redeeming creation units instead of selling portfolio 

securities to meet redemption demands. The selling of portfolio securities could otherwise result in taxable capital gains 

to the ETF that would typically be passed through to the retail 

investor. Nevertheless, the tax efficiency of ETFs is not relevant 

if an investor holds the mutual fund or ETF investment in a 

tax-advantaged account, such as an IRA or a 401(k).

SEC rules require mutual funds and ETFs to disclose in their 

prospectuses after-tax returns. In calculating after-tax returns, 

mutual funds and ETFs must use standardized formulas 
U.S. SECURITIES AND EXCHANGE COMMISSION | 37

similar to the ones used to calculate before-tax average annual 

total returns. A fund’s after-tax returns are discussed in the 

“Investments, Risks and Performance” section of the prospectus. When comparing mutual funds and/or ETFs, be sure to 

take taxes into account.

A Word about Tax Exempt Funds

If an investor invests in a tax-exempt fund—such as 

a municipal bond fund—some or all of the dividends 

will be exempt from federal (and sometimes state 

and local) income tax. The investor will, however, 

owe taxes on any capital gains.

Sources of Information

■ Prospectus and Summary Prospectus

Mutual funds must provide a copy of the fund’s prospectus to 

shareholders after they purchase shares, but investors can—

and should—request and read the mutual fund’s prospectus 

before making an investment decision. There are two kinds of 

prospectuses: (1) the statutory prospectus; and (2) the summary prospectus. The statutory prospectus is the traditional, 

long-form prospectus with which most mutual fund investors 

are familiar. The summary prospectus, which is used by many 

mutual funds, is just a few pages long and contains key information about a mutual fund. The SEC specifies the kinds of 

information that must be included in mutual fund prospectuses and requires mutual funds to present the information 

in a standard format so that investors can readily compare 

different mutual funds.
38 | MUTUAL FUNDS AND ETFS

The same key information required in the summary prospectus is required to be in the beginning of the statutory 

prospectus. It appears in the following standardized order: 

(1) investment objectives/goals; (2) fee table; (3) investments, 

risks, and performance; (4) management—investment advisers 

and portfolio managers; (5) purchase and sale of fund shares; 

(6) tax information; and (7) financial intermediary compensation. Investors can also find more detailed information in the 

statutory prospectus, including financial highlights information.

An ETF will also have a prospectus, and some ETFs may 

have a summary prospectus, both of which are subject to the 

same legal requirements as mutual fund prospectuses and 

summary prospectuses. All investors who purchase creation 

units (i.e., Authorized Participants) receive a prospectus. Some 

broker-dealers also deliver a prospectus to secondary market 

purchasers. All ETFs are required to deliver a prospectus upon 

request and without charge, and the prospectus will usually be 

available on the ETF’s website.

While they may seem daunting at first, mutual fund and 

ETF prospectuses contain valuable information. Here’s some of 

what is included in mutual fund and ETF prospectuses:

• Investment Objective—The prospectus will 

describe the mutual fund’s or ETF’s investment 

objectives or goals. A fund may also identify its type 

or category (e.g., that it is a money market fund or 

balanced fund).

• Fee Table—This table describes the mutual fund’s 

or ETF’s fees and expenses, which include the shareholder fees and annual fund operating expenses 

(discussed on pages 26-32). The fee table includes 
U.S. SECURITIES AND EXCHANGE COMMISSION | 39

an example that will help investors compare costs 

among different mutual funds or ETFs by showing 

them the costs associated with investing a hypothetical $10,000 over a 1-, 3-, 5-, and 10-year period.

• Key Risks—The prospectus will discuss the mutual 

fund’s or ETF’s principal investment risks.

• Financial Highlights Information—This section, 

which generally appears towards the back of the 

prospectus, contains audited data concerning the 

mutual fund’s or ETF’s financial performance for each 

of the past 5 years. Here an investor will find net 

asset values (for both the beginning and end of each 

period), total returns, and various ratios, including 

the ratio of expenses to average net assets, the ratio 

of net income to average net assets, and the portfolio turnover rate. 

■ Statement of Additional Information (SAI)

The SAI explains a mutual fund’s or ETF’s operations in greater 

detail than the prospectus—including the mutual fund’s or 

ETF’s financial statements and details about the history of 

the mutual fund or ETF, its policies on borrowing and concentration, the identity of officers, directors and persons who 

control the mutual fund or ETF, investment advisory and other 

services, brokerage commissions paid on portfolio securities 

transactions, tax matters, and performance such as yield and 

average annual total return information. If an investor asks, 

the mutual fund or ETF must send an SAI. The back cover of 

the mutual fund’s or ETF’s prospectus should contain information on how to obtain the SAI.
40 | MUTUAL FUNDS AND ETFS

■■ Shareholder Reports 

A mutual fund also must provide shareholders with annual 

and semi-annual reports within 60 days after the end of the 

fund’s fiscal year and 60 days after the fund’s fiscal mid-year. 

These reports contain updated financial information, a list 

of the fund’s portfolio securities, and other information. The 

information in the shareholder reports will be current as of 

the date of the report (that is, the last day of the fund’s fiscal 

year for the annual report, and the last day of the fund’s fiscal 

mid-year for the semi-annual report). Investors can obtain all 

of these documents by:

• Visiting the mutual fund’s or ETF’s website;

• Calling or writing to the mutual fund or ETF (all mutual funds and ETFs have toll-free telephone numbers);

• Contacting a broker that sells the mutual fund’s or 

ETF’s shares;

• Searching the SEC’s EDGAR database (www.sec.gov/

edgar/searchedgar/mutualsearch.html) and downloading the documents for free; or

• Contacting the SEC’s Office of Investor Education and 

Advocacy by telephone (800) 732-0330. 
U.S. SECURITIES AND EXCHANGE COMMISSION | 41

Avoiding Common Pitfalls 

Past Performance 

A mutual fund’s or ETF’s past performance is not as important 

as one might think. Advertisements, rankings, and ratings 

often emphasize how well a mutual fund or ETF has performed in the past. But studies show that the future is often 

different. This year’s number one mutual fund or ETF can 

easily become next year’s below average mutual fund or ETF.

For mutual funds and ETFs, be sure to find out how long 

the fund has been in existence. Newly created or small mutual 

funds or ETFs sometimes have excellent short-term performance records. Because newly created mutual funds and ETFs 

may invest in only a small number of stocks, a few successful 

stocks can have a large impact on their performance. But as 

these mutual funds and ETFs grow larger and increase the 

number of stocks they own, each stock has less impact on 

performance. This may make it more difficult to sustain initial results.

While past performance does not necessarily predict 

future returns, it can tell an investor how volatile (or stable) a 

mutual fund or ETF has been over a period of time. Generally, 

the more volatile a fund, the higher the investment risk. If you 

will need your money to meet a financial goal in the near-term, 

you probably can’t afford the risk of investing in a fund with a 

volatile history because you will not have enough time to ride 

out any declines in the stock market.

For index mutual funds and index ETFs, remember that 

these funds are designed to track a particular market index 

and their past performance is related to how well that market 

index did. 
42 | MUTUAL FUNDS AND ETFS

Looking Beyond A Mutual Fund or ETF Name 

Don’t assume that a mutual fund called the “ZYX Stock Fund” 

invests only in stocks or that the “Martian High-Yield Fund” 

invests only in the securities of companies headquartered on 

the planet Mars. The SEC generally requires that any mutual 

fund or ETF with a name suggesting that it focuses on a particular type of investment must invest at least 80% of its assets 

in the type of investment suggested by its name. But mutual 

funds and ETFs can still invest up to one-fifth of their holdings 

in other types of securities—including securities that a particular investor might consider too risky or perhaps not aggressive enough.

Bank Products Versus Mutual Funds 

Many banks now sell mutual funds, some of which carry 

the bank’s name. But mutual funds sold in banks, including 

money market funds, are not bank deposits. As a result, they 

are not federally insured by the Federal Deposit Insurance 

Corporation (FDIC).
U.S. SECURITIES AND EXCHANGE COMMISSION | 43

Money Market Matters

Don’t confuse a money market fund with a money 

market deposit account. The names are similar, but 

they are completely different.

A money market fund is a type of mutual fund. 

It is not guaranteed or FDIC-insured. When an 

investor buys shares in a money market fund, 

he or she should receive a prospectus. 

A money market deposit account is a bank deposit.

It is guaranteed and FDIC-insured. When a saver 

deposits money in a money market deposit 

account, he or she should receive a Truth in 

Savings form.
44 | MUTUAL FUNDS AND ETFS

If You Have a Question or 

Complaint

If you have a question or complaint about your mutual 

fund or ETF, you can send it to us using this online form 

(www.sec.gov/complaint/select.shtml). You can also reach 

us by regular mail, by telephone, or by fax at:

U.S. Securities and Exchange Commission

Office of Investor Education and Advocacy

100 F Street, N.E.

Washington, D.C. 20549-0213

Toll-free: (800) 732-0330

Fax: (202) 772-9295

For more information about investing wisely and avoiding 

fraud, please check out Investor.gov.
U.S. SECURITIES AND EXCHANGE COMMISSION | 45

Glossary of Key Mutual Fund and 

ETF Terms

12b-1 Fees—fees paid out of mutual fund or ETF assets to 

cover the costs of marketing and selling mutual fund shares 

and sometimes to cover the costs of providing shareholder 

services. Distribution fees include fees to compensate brokers 

and others who sell fund shares and to pay for advertising, 

the printing and mailing of prospectuses to new investors, 

and the printing and mailing of sales literature. Shareholder 

Service Fees are fees paid to persons to respond to investor 

inquiries and provide investors with information about their 

investments.

Account Fee—a fee that some mutual funds separately 

charge investors for the maintenance of their accounts. For 

example, accounts below a specified dollar amount may have 

to pay an account fee.

Authorized Participants—financial institutions, which are 

typically large broker-dealers, who enter into contractual 

relationships with ETFs to buy and redeem creation units of 

ETF shares.

Back-end Load—a sales charge (also known as a deferred 

sales charge) investors pay when they redeem (or sell) mutual 

fund shares; generally used by the mutual fund to compensate brokers.
46 | MUTUAL FUNDS AND ETFS

Brokers—an individual who acts as an intermediary between 

a buyer and seller, usually charging a commission to execute trades. 

Brokerage Commissions—A fee investors pay their brokers 

with each purchase or sale of ETF shares. 

Classes—different types of shares issued by a single mutual 

fund, often referred to as Class A shares, Class B shares, and so 

on. Each class invests in the same pool (or investment portfolio) of securities and has the same investment objectives and 

policies. But each class has different shareholder services and/

or distribution arrangements with different fees and expenses 

and therefore different performance results.

Closed-End Fund—a type of investment company that does 

not continuously offer its shares for sale but instead sells a 

fixed number of shares at one time (in the initial public offering) which then typically trade on a secondary market, such as 

the New York Stock Exchange or the Nasdaq Stock Market—

legally known as a closed-end investment company.

Contingent Deferred Sales Load—a type of back-end load, 

the amount of which depends on the length of time the investor held his or her mutual fund shares. For example, a contingent deferred sales load might be (X)% if an investor holds his 

or her shares for one year, (X-1)% after two years, and so on 

until the load reaches zero and goes away completely.
U.S. SECURITIES AND EXCHANGE COMMISSION | 47

Conversion—a feature some mutual funds offer that allows 

investors to automatically change from one class to another 

(typically with lower annual expenses) after a set period of 

time. The mutual fund’s prospectus or summary prospectus 

will state whether a class ever converts to another class.

Creation Units—large blocks of shares of an ETF, typically 

50,000 shares or more, usually sold in in-kind exchanges to 

Authorized Participants. 

Deferred Sales Charge—see back-end load (above).

Discount to NAV—when an ETF’s market price is trading 

lower than the value of the underlying holdings. 

Distribution Fees—fees paid out of mutual fund or ETF assets 

to cover expenses for marketing and selling mutual fund or 

ETF shares, including advertising costs, compensation for brokers and others who sell mutual fund shares, and payments 

for printing and mailing prospectuses to new investors and 

sales literature prospective investors—sometimes referred to 

as 12b-1 fees.

Exchange Fee—a fee that some mutual funds charge shareholders if they exchange (transfer) to another mutual fund 

within the same fund group.
48 | MUTUAL FUNDS AND ETFS

Exchange-Traded Funds—a type of an investment company 

(either an open-end company or UIT) that differs from traditional mutual funds, because shares issued by ETFs trade on 

a secondary market and are only redeemable by Authorized 

Participants from the fund itself in very large blocks (blocks of 

50,000 shares for example) called creation units.

Expense Ratio—a mutual fund’s or ETF’s total annual operating expenses (including management fees, distribution (12b-1) 

fees, and other expenses) expressed as a percentage of average net assets.

Front-end Load—an upfront sales charge investors pay when 

they purchase mutual fund shares, generally used by the 

mutual fund to compensate brokers. A front-end load reduces 

the amount available to purchase fund shares.

Index Fund or ETF—describes a type of mutual fund or ETF 

whose investment objective typically is to achieve the same 

return as a particular market index, such as the S&P 500 

Composite Stock Price Index, the Russell 2000 Index, or the 

Wilshire 5000 Total Market Index.

Investment Adviser—generally, a person or entity who 

receives compensation for giving individually tailored advice 

to a specific person on investing in stocks, bonds, or mutual 

funds. Some investment advisers also manage portfolios of 

securities, including mutual funds.
U.S. SECURITIES AND EXCHANGE COMMISSION | 49

Investment Company—a company (corporation, business 

trust, partnership, or limited liability company) that issues 

securities and is primarily engaged in the business of investing 

in securities. The three basic types of investment companies 

are open-end funds (mutual funds and most ETFs), closed-end 

funds, and unit investment trusts (some ETFs).

Load—see Sales Charge.

Management Fee—fee paid out of mutual fund or ETF assets 

to the fund’s investment adviser or its affiliates for managing 

the fund’s portfolio, any other management fee payable to 

the fund’s investment adviser or its affiliates, and any administrative fee payable to the investment adviser that are not 

included in the “Other Expenses” category. A fund’s management fee appears as a category under “Annual Fund Operating 

Expenses” in the Fee Table.

Market Index—a measurement of the performance of a 

specific basket of stocks or bonds considered to represent 

a particular market or sector of the U.S. stock market or the 

economy. For example, the Dow Jones Industrial Average (DJIA) 

is an index of 30 blue chip U.S. stocks of industrial companies 

(excluding transportation and utility companies).

Mutual Fund—the common name for an open-end investment company. Like other types of investment companies, 

mutual funds pool money from many investors and invest 

the money in stocks, bonds, short-term money-market instruments, or other securities. Mutual funds issue redeemable 

shares that investors purchase directly from the fund (or 
50 | MUTUAL FUNDS AND ETFS

through a broker for the fund) instead of purchasing from 

investors on a secondary market.

NAV (Net Asset Value)—the per-share value of the mutual 

fund’s or ETF’s assets minus its liabilities. SEC rules require 

mutual funds and ETFs to calculate the NAV at least once daily.

To calculate the NAV per share, a fund subtracts the fund’s

liabilities from its assets and then divides the result by the 

number of shares outstanding.

No-load Fund—a mutual fund that does not charge any type 

of sales load. But not every type of shareholder fee is a sales 

load, and a no-load fund may charge fees that are not sales 

loads. No-load funds also charge operating expenses.

Open-End Company—the legal name for a mutual fund 

and most ETFs. An open-end company is a type of investment company.

Operating Expenses—the costs a mutual fund or ETF incurs 

in connection with running the fund, including management 

fees, distribution (12b-1) fees, and other expenses.

Portfolio—an individual’s or entity’s combined holdings of 

stocks, bonds, or other securities and assets.

Premium to NAV—when an ETF’s market price is trading 

higher than the value of the underlying holdings. 

Prospectus—disclosure document that describes the mutual 

fund or ETF. Each mutual fund or ETF has a prospectus. The 
U.S. SECURITIES AND EXCHANGE COMMISSION | 51

prospectus contains information about the fund’s costs, 

investment objectives, risks, and performance. You can get a 

prospectus from the mutual fund company or ETF sponsor 

(through its website or by phone or mail). Your financial professional or broker can also provide you with a copy.

Purchase Fee—a shareholder fee that some mutual funds 

charge when investors purchase mutual fund shares. Not the 

same as (and may be in addition to) a front-end load.

Redemption Fee—a shareholder fee that some mutual 

funds charge when investors redeem (or sell) mutual fund

shares within a certain time frame of purchasing the shares.

Redemption fees (which must be paid to the fund) are not the 

same as (and may be in addition to) a back-end load (which is 

typically paid to a broker). The SEC generally limits redemption 

fees to 2%.

Sales Charge (or Load)—the amount that investors pay when 

they purchase (front-end load) or redeem (back-end load)

shares in a mutual fund, similar to a brokerage commission. 

Secondary Market—markets where existing securities are 

bought and sold.

Shareholder Fees—fees charged directly to investors in 

connection with particular investor transactions such as

buying, selling, or exchanging shares or periodically with 

respect to account fees including sales loads, purchase or 

redemption fees.
52 | MUTUAL FUNDS AND ETFS

Shareholder Service Fees—fees paid out of mutual fund or 

ETF assets to persons to respond to investor inquiries and 

provide investors with information about their investments. 

See also 12b-1 fees.

Statement of Additional Information (SAI)—disclosure 

document that provides information about a mutual fund or 

ETF in addition to, and sometimes in more detail, than the 

prospectus. Although mutual funds and ETFs are not required 

to provide investors with the SAI, they must give investors the 

SAI upon request and without charge.

Summary Prospectus—a disclosure document that summarizes key information for mutual funds and ETFs.

Total Annual Fund Operating Expense—the total of a 

mutual fund’s or ETF’s annual fund operating expenses, 

expressed as a percentage of the fund’s average net assets. 

The total annual fund operating expenses is included in the 

fund’s fee table in the prospectus.

Unit Investment Trust (UIT)—a type of investment company 

that typically makes a one-time public offering of only a specific, fixed number of units. A UIT will terminate and dissolve 

on a date established when the UIT is created (although some 

may terminate more than fifty years after they are created). 

UITs do not actively trade their investment portfolios.

54 | MUTUAL FUNDS AND ETFS SEC Pub. 182 (12/16)