Investment Company Definition Types Example Benefits

Investment Company Definition

The company shares the profit and losses with the investor in proportion to the investor’s interest in the company. They employ financial managers who make important financial decisions on behalf of the investors. The investors can thus enjoy access to many investment products that otherwise need extensive research and preparation.

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Key Takeaways

An investment company is any trust or entity that pools capital from investors to reinvest it in various asset classes. They can be publicly or privately owned. The company shares the profit or losses with its investors in proportion to the investor’s share.The three main types of investment companies are closed-end, open-end, and unit investment trusts.Investment companies help small investors access professional financial management services, minimize risk, and diversify their portfolios. They employ experienced finance managers who can make clever financial decisions for the client, especially during times of crisis.

How Does an Investment Company Work?

An investment company pools resources from many investors and invests substantially in various asset classesAsset ClassesAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples.read more and security instruments. The company collects funds from multiple investors. It then invests its entirety in various types of assets, including debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more, equityEquityEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company’s balance sheet.read more, shares, and properties.

The company will earn returns on its portfolio in interest, dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more, etc. These returns are then forwarded to the individual investors, based on their share of the total investment fund. For example, suppose a company invests $2 million, and one has invested $40,000 with this company. They will get 2 percent of whatever returns the company generates.

The type of assets chosen to invest will depend on the overarching management objective of that particular company. For instance, suppose the aim is the quick growth of investments. Then a large portion of funds will be invested in shares and equity, as these assets yield the highest returns.

Suppose the objective is to generate stable, long-term returns while minimizing risk. Then debt securities and commercial real-estate investments will be preferred, as they are less volatile than equity.

Investment companies in the US are regulated under the Securities and exchanges commission (SEC) . They must also be registered under the Investment company act of 1940 and the Securities act of 1933.

Benefits of an investment company

An individual investor will get several benefits from the pooling of funds. For instance, investment companies employ experienced and qualified finance managers. As a result, they can provide professional investment management services that allow investors to reach their investment goals quickly and with minimal risk.

Investment companies also provide ample opportunities for diversification. For example, an individual investor might research a single asset class like the stock marketStock MarketStock Market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset, and they are willing to sell off something they have at a specific price.read more or real estate and then invest all the money there. It is extremely difficult for one person to have in-depth knowledge about different investment vehicles or assets. This can also be risky as one would lose all their money if the stock market crashes or if the housing market collapses, like the subprime mortgage crisis of 2008Subprime Mortgage Crisis Of 2008A subprime mortgage is a loan against property offered to borrowers with a weak or no credit history. Since the risk of recovering is high, the interest rate charged on such mortgages is higher so that the lender can recover a maximum amount at the beginning of the loan.read more.

An investment company can help investors diversify their investments with the help of multiple financial managers and experts who have great knowledge about various asset classes. As a result, they can take the accumulated savings of many different investors and invest the money wisely in real estate, stock market, optionsOptionsOptions are financial contracts which allow the buyer a right, but not an obligation to execute the contract. The right is to buy or sell an asset on a specific date at a specific price which is predetermined at the contract date.read more, and commodities.

Examples

Let us take a look at some investment company examples. Imagine a person who has lived frugally for a few years and has managed to save a substantial portion of income. They would now like to invest their savings to earn a profit, either in interest, dividends, or asset appreciation.

They could invest money directly in real estate or the stock market, but this would require a substantial amount of time-consuming research. This is where investment companies come in. Investing indirectly through a company can take some emotional weight out of a person’s financial decisions. One will have experienced financial experts guiding them and managing their portfolioManaging Their PortfolioPortfolio management involves overseeing a set of investments, including securities, bonds, exchange-traded funds, mutual funds, cryptocurrencies, etc., on a personal or professional levelread more, ensuring that they stick to the long-term goals and ignore the daily market fluctuations, scary though they might be.

With countries and states still struggling to recover from the impacts of the pandemic, the importance of investment companies has never been more evident. Unfortunately, when the economyEconomyAn economy comprises individuals, commercial entities, and the government involved in the production, distribution, exchange, and consumption of products and services in a society.read more slows down or shows signs of going into recession, individual investors tend to panic, withdrawing their investments from the market. They may also make counterproductive investment decisions driven by fear rather than sound market analysis.

Protecting investments during a crisis

It is rarely a good idea to exit the market when you have recently suffered a major loss. This instinctive reaction to losing a large amount of money often causes people to sell at low prices and buy at higher rates later after the market has once again stabilized.

An investment company will help a person define clear, achievable, and measurable goals, determine how much risk they can take on, and diversify their portfolioDiversify Their PortfolioPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio.read more so that they don’t face financial ruin if one asset class is in jeopardy. This will help an investor stay on course and come out of these economically turbulent times relatively unscathed.

However, when one chooses an investment company, they must ensure that the company does not charge any hidden fees or other associated costs. If one chooses a company without doing some research into their fee structure, they could end up paying nine times more money in the form of seemingly small costs.

Types of Investment Company

The three major categories of registered investment companies are as follows:

Open-end : Commonly known as mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more, these companies sell shares constantly. They are always ready to purchase their shares from investors at net asset valueNet Asset ValueNet Asset Value is calculated by subtracting the total value of the entity’s liabilities from the total value of its assets and dividing the result by the total number of outstanding shares.read more. Therefore the shares of open-end companies are redeemable.Closed-end : These investment companies list a fixed number of shares traded in the stock market. They do not generally buy back their shares from investors.Unit investment trusts: This is an investment company that holds a static portfolio containing a fixed set of not actively traded securities. The UNIT will dissolve on a particular date when its portfolio gets liquidated and the proceeds handed over to investors. The shares of a UIT can therefore be called redeemable.