Funds attract outside investors to pool their capital into a collection of investment the fund manager has assembled, either actively or passively, giving each access to wider range of securities. Funds can be classified based on when and how they can be bought and sold as well as the kinds of markets in which they invest.
The big three
From an investor's point of view, how the funds are traded and how they charge their fees are crucial. Exchange-traded funds offer minimal cost and easy electronic trading in passively managed vehicles like index funds, wheras mutual funds, whose shares generally don't trade on exchanges (although see below), claim to beat the market through active management of the fund's portfolio and charge management fees of up to 2.5 percent of the portfolio's value. Hedge funds are managed more aggressively than mutual funds and solicit capital only from experienced private investors and charge higher management fees of up to 3.5 percent plus performance fees on profits. But all three offer lower trading costs to the individual relative to their market exposure because the funds can leverage their (sometimes huge) economies of scale.
Some mutual funds - called closed-end funds or investment trusts - are traded on exchanges after an IPO but the fund does not redeem oustanding shares or issue new ones before maturity. The fund's price is then determined by market demand like listed stocks. Closed-end funds are also called publicly-traded funds, not to be confused with exchange-traded funds, or ETFs.