Basics

• A mutual fund is a a collection of funds managed by a relatively small number of individuals on behalf of a large number of investors. They are highly popular investment vehicles, since most people find it far more practical to invest in a professionally managed fund than to follow their own investments on a daily basis. The pool of money in the mutual fund is managed by dedicated financial professionals who have access to far better research and analysis than most amateur investors, and they have substantial experience in the field. In return, the fund charges a percentage fee to pay for the expertise of these professionals. Fees also go toward general expenses and profits.
  
  

Open vs. Closed

• Mutual funds can be open or close-ended. Open-ended funds place no limit on how much money they will accept from investors. It is therefore common to see large money flow into these funds following a successful year, as investors "chase the winners." Close-ended funds, on the other hand, limit the amount of money they accept, and new investors will have to buy shares in such funds from other investors who are exiting the fund. Investing in these funds is much like buying stock in an established company, where someone must be willing to sell his shares before you can buy them.
  
  

Publicly Offered Funds

• Publicly offered mutual funds, which can be open or close-ended, are defined by the IRS as funds that satisfy the following requirements: They are continuously offered following the initial public offering; they are regularly traded in the open market; or they are held by 500 or more investors at all times during the year.
  
  These funds deduct fees and expenses directly from the dividends they pay you; therefore, they must send you form 1099-DIV detailing such deductions. As the dividends paid to you are net of any fees and expenses, they will already have been deducted from your taxable income. This means that you cannot include the fees and expenses charged by publicly offered mutual funds in your itemized deductions.
  
  

Nonpublicly Offered Funds

• Mutual funds that do not satisfy the criteria for publicly offered mutual funds are considered nonpublic funds. These funds are not legally obligated to send you form 1099-DIV and may send a substitute form instead. If, per the year-end paperwork, the dividends paid to you are net of expenses, you cannot deduct fees and expenses by including them in your itemized deductions. If, however, the fees and expenses have not already been deducted from the dividends or earnings reported to you, you may deduct them from your taxable gross income.
  
  

The 2 Percent Rule

• When itemizing investment management fees and other investment-related expenses, keep the 2 percent rule in mind: Your total deductions for investment expenses cannot exceed 2 percent of your total gross income for the year.