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Open-ended mutual fund (part 1)

Introduction to Open-Ended Mutual Funds
Created by Sal Khan.

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Video transcript

Let's say Pete over here thinks that he's a pretty good investor. So what he does is, he has an idea that says, look, I'm going to create a corporation. And I'm going to get a bunch of people to contribute money to that corporation. And then I'll manage that money, and maybe I'll take a little fee for myself, so that I can maybe hire some analysts, or get some computers, or get some office space. What he does is he sets up a corporation. Let's say he sets up a corporation right over here. And let's say the way he first sets up the corporation, let's say it just has four shares. And I'm making the number really small just to make the drawing and the math easy. This wouldn't be realistic. Normally it would be something in the hundreds or thousands of shares, or maybe even more than that. But let's say it has four shares. And let's say all the four shares are owned by Pete initially, just to simplify the explanation. And he puts in $400 into this corporation. So another way to think about it, in exchange for him putting $400 into this corporation, he gets four shares, or each share is worth $100, each of these shares right over here. And so what he does is he registers this corporation-- and I'm talking about a US-specific case, but there's similar types of organizations in other countries-- he registers this organization right over here with the US SEC, Securities and Exchange Commission. And he also registers himself with the SEC. Or even better, he registers a management company that he runs with the SEC. So let's call it Pete Inc. It's a corporation he starts off that he also registers with the SEC. And when he registers with the SEC, he tells them that look, this company right over here, we're going to issue more shares for more people to contribute money. And I'm going to manage this money right over here, and I'm just going to take a percentage of the total assets under management. Sometimes you'll see AUM used. That just means assets under management. That will go to Pete Inc. every year for figuring out the best place to invest this money. And it's usually on the order of about 1%, sometimes a little bit less, sometimes a little bit more. So 1% per year. So right now, with only $400 under management, it would only be about $4 per year. But since he registered with the SEC, he can call himself a mutual fund, and he can solicit funds from the public. So it is a mutual fund, he has jumped through all the hoops that the SEC sets up for him. So he can market himself as some type of great fund manager. We don't know if that's true or not. And he can also solicit funds from the public. And we're going to see in future videos, there other funds, especially hedge funds, that one, they can't market, and they can't take funds from the public. Those can only take funds from certain types of sophisticated investors. And what happens in Pete's fund, and this is going to be an open ended mutual fund that we're showing here, and most mutual funds are like that. Let's say that Sal comes along, he likes Pete's marketing materials, and he says hey, I want Pete to manage my money too. So Sal goes and he gives $100, and says, Pete, give me a share. So Pete creates another share right over here, he creates another share he gives it to Sal. So he gets one share, that's me. I get one share. And in exchange, I gave $100 to the fund. So now the fund has $500. So this is another $100 right over here. And now Pete's annual fee is going to be 1% of this whole thing, or $5 a year. And if this whole thing grows, let's say this whole thing doubles from $500, let's say it doubles to $1,000, then that $1,000 is essentially split amongst these five shares now. So all of the people will essentially have their money doubled, minus whatever Pete's expenses are. In the next few videos, I'll go over a little bit more of the mechanics of an open ended mutual fund.