Investment companies

For many people, the world of finance is large, complicated, and intimidating. For those that don’t want to put the required effort into investing, investment companies can be very helpful.

Investment companies are institutions that invest their customers’ money on their behalf. You may have heard of a mutual fund, which is a type of investment company. When an investor purchases shares in a mutual fund, they hand their money to financial professionals that invest their funds. Investments like mutual funds were created for customers who lack the knowledge, time, or patience to invest.

Investment companies have been around since the 1920s but weren’t formally recognized or regulated until 1940. In the early 1900s, the financial markets were characterized by a lack of information, deceit, and market manipulation. During and after the Great Depression, there were many financial regulations signed into law to prevent financial fraud. One of those laws was the Investment Company Act of 1940.

The Investment Company Act of 1940 formally defined investment companies and regulated their activities. In this chapter, we’ll discuss specific types of investment companies, how they’re regulated, and their suitability for investors.

When investment companies were defined by the Investment Company Act of 1940, three separate categories of investment companies were created: management companies, unit investment trusts, and face amount certificates. We’ll discuss each in detail throughout this chapter, but for now it’s important that you know the categories.

Management companies are a type of investment company that manages their customers’ money. There are open-end management companies, also known as mutual funds, and closed-end management companies, also known as closed-end funds. The two types of management companies are unique and different, but both focus on making their customers money through managing portfolios of investments.

Unit investment trusts (UITs) also invest their customers’ money, but maintain fixed and unmanaged portfolios of securities.

Last, face amount certificates are a category of investment company, but are not popular today. In the past, they were used alongside mortgages with banks. Before mortgages were modernized with monthly payments consisting of both interest and principal, a home buyer would only make monthly payments of interest to their bank. At the end of the mortgage, it was expected that the borrower repaid all of their principal at once to the bank. To ensure the payment would be made, banks required borrowers to make perpetual payments into a face amount certificate. Face amount certificates are structured to grow into the amount of the principal on the home loan, which enables the borrower to make their required principal payment.

With the current structure of mortgages, face amount certificates are largely non-existent today. For the exam, you’ll usually only need to know that they are a category of investment company.