- Like stocks, mutual fund investors buy a number of shares in a given fund. Unlike stocks, they buy these shares directly from the fund itself; when new investors arrive, the fund sells new shares at that day's closing price. When old investors leave, the fund gives them cash in exchange for shares, reducing the number of shares outstanding. When an investor withdraws all of their cash, they are removed from the list of fund shareholders.
- For most mutual funds, deposits and withdrawals are a daily event. They keep cash on hand to deal with normal fluctuations in the quantity of shares owned by outside investors. Over time, if a fund is getting more deposits than withdrawals, it may reduce cash on hand and invest this money in new assets. If the fund's withdrawals exceed deposits, it will have to consistently sell assets to keep returning cash.
- When investors pull money out of a mutual fund, it may be forced to sell assets to cover a cash shortfall. While mutual funds can generally do this in an orderly way, it does have effects on asset prices. When there are more sales than purchases, prices tend to decline. This can mean that a mutual fund ends up losing money as it sells assets, especially if this selling occurs in a broadly declining market.
- Some investors withdraw money from mutual funds for personal financial reasons, like re-balancing their portfolio (selling bonds to buy more stock) or making a major purchase. However, many investors withdraw money from mutual funds because the market has declined and they fear further declines. This can create a vicious cycle, since each withdrawal forces the fund to sell more stock, thus pushing prices down more. Given the size of mutual funds, mutual fund withdrawals often play a major role in broad market fluctuations.
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