Reflections: Mutual Funds and Real Estate Investments Principles of Finance BUS 219 Dr. Coty Keller

What is a Mutual Fund? An investment alternative where money from investors is pooled to buy stocks, bonds, and other financial securities selected by professional managers. Many people choose mutual funds for their retirement account investments. –401(k) or 403(b) –IRA –Roth IRA MANY other financial objectives too 16-2

Mutual Funds are Popular 92 million individuals in 54 million households in the U.S. own mutual funds. Over 8,000 mutual funds by Over $8 trillion in assets owned by mutual funds in the U.S. by

Why Investors Purchase Mutual Funds Professional management. –Who is the fund’s manager? –Managers can change. –Be aware of the scandal involving late trading. Diversification. –Investors funds are used to purchase a variety of investments. This variety provides some safety. 16-4

Closed- and Open-End Funds Closed-end funds (7% of funds). –Shares are issued by an investment company only when the fund is organized. –After all original shares are sold you can purchase shares only from another investor who is willing to sell. –Traded on exchanges and over-the-counter. Open-end funds (91% of funds). –Shares are issued and redeemed by the investment company at the request of investors. –Investors can buy and sell shares at the net asset value (NAV). 16-5

Net Asset Value (NAV) Value of the fund’s portfolio - Liabilities Number of shares outstanding For most mutual funds, NAV is calculated at the close of trading each day. 16-7

Load Funds and No-Load Funds Load Fund. –Investors pay a commission (sales charge) up to 8.5% every time they purchase shares. This is sometimes called a front load. (Class A shares) –Average charge is 3-5% for which an investor can get purchase advice and explanations. No-Load Fund. –Investors pay no sales charge up front. –You deal directly with the fund with 800 numbers or web sites, or from discount brokers. 16-8

Management Fees and Other Charges Contingent deferred sales load (back-end load) –Charged upon withdrawal of funds (1-5%). –Generally decreases on a sliding scale depending on the number of years shares are held. Management fee. –Charged yearly (.5%-1.25% average) based on a percentage of the funds asset value. 16-9

Number of Mutual Funds by Type* *Source: Year 2000 data from the U.S. Bureau of the Census, Statistical Abstract of the United States, 2001, page 744.

Classification of Mutual Funds Stock funds. –Aggressive growth funds buy stocks in small, fast- growing companies. –Equity income funds invest in stock of companies with a long history of paying dividends. –Growth buy stock in companies with higher-than- average revenue and earnings growth. –Global funds buy stock in companies in the U.S. and other countries, while international funds buy stock only in companies outside the United States. –Index buys stocks that mirror an index. –Large-cap funds invest in companies with capitalization of $5 billion or more. –Mid-cap funds buy stock in companies whose capitalization is between $1 and $5 billion

Classification of Mutual Funds (continued) –Regional funds buy stock in companies in a specific region of the world. –Sector funds buy stock in companies in a particular industry such as biotechnology. –Small-cap funds buy stock in lesser-known companies with a capitalization of less than 500 million. –Socially responsible funds avoid investing in companies that produce harmful products

Classification of Mutual Funds Bond funds. –High-yield (junk) bond funds buy corporate bonds that are higher risk and higher yield. –Index bond funds invest in a sampling of bonds included in an index. –Intermediate corporate bonds (5-10 years). –Intermediate U.S. bond funds buy treasury notes with maturities of 5-10 years. –Long-term corporate bonds (> 10 years)

More Classification of Mutual Funds –Long-term U.S. bond funds: U.S. Treasury and U.S. zero-coupon bonds with maturities > than 10 years. –Municipal bonds: Invest in municipal bonds that provide investors tax-free interest income. –Short-term U.S. bond funds invest in U.S.Treasury issues of 1-5 years. –Short-term corporate bond funds: Investment grade bonds with maturities of 1- 5 years. –World bond funds buy bonds of foreign companies and governments

Classification of Mutual Funds Other funds. –Asset allocation funds: invest in various asset classes, such as stocks, and bonds, with precise amounts within each type. –Balanced funds: Invest in both stocks and bonds, with the primary objectives of conserving principal, providing income as well as growth. –Money market funds: Invest in CD’s, government securities, and other safe investments

Families of Funds A family of funds exists when one investment company manages a group of mutual funds. Each fund in the family has a different financial objective. Exchange privileges allow you to move your money from one fund to another within the fund family with little or no charge

Steps to Evaluate Mutual Funds Are you ready to invest in mutual funds? Determine your risk tolerance. Determine your investment objectives. Obtain the money you need to invest. A fund’s objective should match your investment objective. Evaluate any mutual fund before buying or selling ( Consider managed funds vs. indexed funds 16-17

Internet Sources of Fund Information Use web sites to research a fund. – – – (also other advisory services, such as Value Line). Subscription fees. Public libraries often give access for free) – Check mutual fund companies Internet sites. – –

Reading a Mutual Fund Quote in the Newspaper Net asset value and asset value change. The fund family and fund name. Fund objective. Total return over various time periods. Ranking among funds with the same objective. Sales load fees if any, or no load (NL). Annual expenses

Other Sources of Fund Information Mutual fund prospectus tells the funds objective and: –A statement describing the risk factors. –A description of the fund’s past performance. –A statement describing the type of investments in the fund’s portfolio. –Information on how to open an account. –Dividends, distributions and taxes. –Information about the fund’s management. –The process for investors to buy or sell shares. –Services provided to investors. –The turnover ratio of the fund’s investments

Other Sources of Fund Information Mutual fund annual report. –Performance, investments, assets and liabilities. Financial Publications. –Business Week, Forbes, Kiplinger's Personal Finance and Money are sources of information. –Business Week’s mutual fund survey includes information such as the... Fund’s overall rating compared to all other funds, and to funds in the same category. Fund size, sales charge and expense ratio. Performance for best and worst quarters

Mutual Fund Transactions You can open an account from $250 to $3,000 and up depending on the fund & family (Some will let you in for $50 if you commit to recurring purchases – a good idea: dollar cost averaging) Open-end, no-load directly from the investment company by phone, mail, online, or from a discount broker. Closed-end or exchange-traded funds are purchased through a broker; traded on stock exchanges and over-the-counter

Mutual Fund Returns There are several ways you can get a return on your investment (Income & Growth) –Capital gains: sell shares at a price > than you paid (Report on Schedule D and 1040). –Income dividends: earnings funds pay to shareholders from dividend and interest income (Taxed as regular income). –Capital gain distributions: Payments to shareholders from sale of securities held by the fund (Show on Schedule D and 1040). –Income and capital gain distributions can be automatically reinvested (should be to take advantage of the magic of compounding)

Mutual Fund Features Automatic investments: Money is taken from your checking account monthly and invested in a fund. (Dollar Cost Averaging) Telephone Switching: Call your fund and move money from one fund to another in the same family. Withdrawals: Various withdrawal options; you can withdraw funds by phone, letter, online, etc

Mutual Fund Project? Find a fund that you feel would be a good investment for you, given your financial goals, investment objectives and tolerance for risk Research can include going online to or other sources No too late to change your learning agreement. Just send me another proposal

Real Estate Investments Types Examples Advantages Disadvantages

Real Estate Investment Types  Direct. –As the investor, you hold legal title to the property. –Your home as an investment. A place to live. A major asset of most households. Shelter income from taxes if you have a large mortgage - interest is deductible. Possible hedge against inflation.Be aware of possible real estate “bubbles.” 17-2

Examples of Direct Real Estate Investments Your primary home. A vacation home. –Tax advantages depend on if the IRS views it as your second home or as a rental property. –If you don’t rent it more than 14 days a year you can write off mortgage interest and property tax. –Primary reason to own a vacation home is because you want to use it. 17-3

Examples of Direct Real Estate Investments Undeveloped land. –Can be tremendous gains but this type of investment poses enormous risks. All the money is riding on a single parcel of land. –Most people buy land with the idea of subdividing the land (continued)

More Examples of Direct Real Estate Investments Commercial property: land and buildings that produce lease or rental income. Examples are: –Most common investment of this type is a duplex or small apartment building. It also includes hotels, office buildings, stores, and many other types of commercial establishments. –Will income be greater than expenses? –Tax deductions, such as depreciation and property taxes are limited to the amount of rental income you receive 17-5

Real Estate Investments Types  Indirect –Real estate syndicates. A syndicate is a temporary association of individuals or firms organized to perform a specific task that takes a large amount of capital. Can be organized as a corporation, trust, or limited partnership. Provide professional management and limited liability for its members, and diversification, if several properties are owned. 17-6

Examples of Indirect Real Estate Investments Real estate limited partnerships. – A limited partnership has a general partner who has unlimited liability and sells participation units to the limited partners. The partner’s liability is limited to the extent of their initial investment, such as $10,

Examples of Indirect Real Estate Investments –Real estate investment trusts (REIT). REITs are similar to a mutual fund or investment company and trade shares. May buy properties and/or invest in first and second mortgages. Equity REITs own properties; mortgage REITs own mortgages; hybrid REITS own both properties and mortgages –Participation certificates. A risk-proof real estate investment. Equity investment in a pool of mortgages that have been purchased by one of several government agencies, such as Ginnie Mae and Freddie Mac (continued)

Advantages of Real Estate Investments A hedge against inflation & risk of stocks & bonds (Diversification!) Easy entry as in REITs or as a limited partner (such as investing $5,000 to own part of an apartment building) Limited financial liability—limited partners. No management concerns -REITs Direct Ownership offers –Financial leverage -using borrowed funds –Tax shelters (mortgage interest & real estate taxes are deductible) 17-9

Disadvantages of Real Estate Investments Illiquidity except REITs Declining property values. Lack of diversification- if real estate is all you have Lack of a tax shelter for real estate syndicates. Long depreciation period. Management problems—direct real estate

Richest Man in Babylon Spend less than you make Save the difference - regularly Diversify You will accumulate wealth Time proven method: Regular savinging into mutual funds (and REITs)