For many people, finance can feel large, complicated, and intimidating. If you don’t want to research and manage investments on your own, investment companies can fill that role.
Investment companies are financial institutions that invest customers’ money on their behalf. You may have heard of a mutual fund, which is one type of investment company. When you buy shares of a mutual fund, you’re pooling your money with other investors and turning it over to professional managers who invest it according to the fund’s strategy. Products like mutual funds were designed for investors who don’t have the time, knowledge, or desire to build and manage a portfolio themselves.
Investment companies have existed since the 1920s, but they weren’t formally defined and regulated until 1940. In the early 1900s, financial markets often suffered from limited information, deception, and market manipulation. During and after the Great Depression, Congress passed several laws aimed at reducing fraud and improving market integrity. One of those laws was the Investment Company Act of 1940.
The Investment Company Act of 1940 formally defined investment companies and set rules for how they operate. In this chapter, we’ll cover the main types of investment companies, how they’re regulated, and when they may (or may not) be suitable 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 cover each in detail throughout this chapter, but you’ll want to recognize these three categories right away.
Management companies are investment companies that actively manage customers’ money. There are:
These two structures work differently, but both are designed to seek returns by holding a portfolio of investments.
Unit investment trusts (UITs) also invest customers’ money, but they typically hold a fixed, unmanaged portfolio of securities.
Last, face amount certificates are a category of investment company that isn’t common today. Historically, they were used alongside certain mortgage structures at banks. Before modern mortgages (with monthly payments that include both interest and principal), a borrower might pay only interest each month and then repay the entire principal in a lump sum at the end of the loan. To help ensure that lump-sum payment would be available, banks required borrowers to make ongoing payments into a face amount certificate. The certificate was designed to grow to the amount needed to repay the mortgage principal.
Because modern mortgages amortize principal over time, face amount certificates are largely non-existent today. For the exam, you’ll usually only need to know that they’re one of the three investment company categories.
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