In 1924, Massachusetts Investors Trust became the first open-end mutual fund in America, allowing everyday investors to own a diversified portfolio of stocks. Today, over $30 trillion sits in U.S. mutual funds alone—more than the GDP of most countries.
Understanding how investment companies work is essential for any securities professional. This chapter covers mutual funds, ETFs, REITs, and other packaged products.
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Section 1: Investment Company Basics
Investment companies pool money from investors to create diversified portfolios. They must register under the Investment Company Act of 1940.
Types of Investment Companies
| Type | Description |
|---|---|
| Face-amount certificates | Obsolete product |
| Management companies | Open-end (mutual funds) and closed-end funds |
| UITs | Fixed portfolio; shares redeemable to issuer |
Open-End vs. Closed-End Funds
| Feature | Open-End (Mutual) | Closed-End |
|---|---|---|
| Shares | Unlimited | Fixed number |
| Trading | Redeemed at NAV | On exchange |
| Price vs. NAV | Always at NAV | May differ |
Types of Mutual Funds
| Fund Type | Objective |
|---|---|
| Growth | Capital gains from growing companies |
| Growth & Income | Blue chips with dividends + growth |
| Value | Undervalued stocks |
| Income | Fixed-income securities |
| Balanced | Mix of equities and bonds |
| Index | Track a benchmark (S&P 500) |
| Sector | Specific industry/region |
| Target-date | Shifts to conservative over time |
Section 2: Mutual Fund Pricing & Share Classes
NAV and POP
Or: POP = NAV ÷ (100% - Sales Charge%)
Test Tip: Maximum sales charge for mutual funds is 8.5% of POP under FINRA rules.
Share Classes
| Class | Sales Charge | 12b-1 Fees | Best For |
|---|---|---|---|
| A | Front-end | Lower | Large/long-term investments |
| B | Back-end (CDSC) | Higher | Intermediate-term |
| C | None/Level | Higher | Short-term investors |
Breakpoints
Breakpoints are quantity discounts. Ways to reach them:
- Combination privilege: Combine purchases across fund family
- Rights of accumulation: Current holdings + new purchases
- Letter of intent: Commit to invest over 13 months
Prohibited Practices
- Breakpoint selling: Selling just below breakpoint
- Switching: Unjustified fund family changes
- Selling dividends: Buying just before distribution
Section 3: ETFs, REITs & Other Products
Exchange-Traded Funds (ETFs)
| Feature | ETFs | Mutual Funds |
|---|---|---|
| Trading | Throughout day | Once daily at NAV |
| Margin/Short | Yes | No |
| Tax efficiency | More efficient | Less efficient |
| Sales charges | No (commission) | May have |
Leveraged: 2× or 3× the index return (daily)
Inverse: Move opposite to index
Suitable only for sophisticated short-term speculators.
REITs
REITs invest in real estate (equity REITs) or mortgages (mortgage REITs). Must distribute 90% of income to shareholders.
| Type | Description |
|---|---|
| Private REITs | Not SEC registered; institutional only; illiquid |
| Non-listed REITs | SEC registered but not traded; limited liquidity |
| Listed REITs | Trade on exchange; liquid |
Other Products
| Product | Description |
|---|---|
| Hedge Funds | Private partnerships; aggressive strategies; accredited investors only |
| DPPs | Limited partnerships; pass-through tax treatment; illiquid |
| Variable Annuities | Insurance products with investment component |
| Concept | Key Details |
|---|---|
| Mutual funds | Open-end; redeemable at NAV; forward pricing |
| Closed-end funds | Fixed shares; trade at market price on exchange |
| Max sales charge | 8.5% of POP (FINRA rule) |
| Class A vs B vs C | Front-end vs back-end vs level load |
| ETFs | Trade like stocks; can margin/short; tax efficient |
| REITs | Distribute 90% income; real estate investment |
Chapter 6 Key Terms Glossary
| Term | Definition |
|---|---|
| NAV | (Assets - Liabilities) ÷ Shares |
| POP | NAV + Sales Charge |
| Forward pricing | Orders filled at next NAV |
| Breakpoint | Quantity discount on sales charges |
| 12b-1 fee | Annual marketing/distribution fee |
| Class A | Front-end load |
| Class B | Back-end load (CDSC) |
| Class C | Level load |
| No-load | No sales charges |
| ETF | Exchange-traded fund |
| REIT | Real estate investment trust |
| UIT | Unit investment trust |
| Subchapter M | Distribute 90% to avoid double taxation |
Chapter 6 is one of the most heavily tested areas on the Series 7. Understanding mutual fund pricing, share classes, and the differences between packaged products is essential.