Mutual Funds Financial Literacy

What We Will Cover What is a Mutual Fund? Advantages and Disadvantage of Mutual Funds Costs of Mutual Funds Types of Mutual Funds ETFs Buying a Mutual Fund

What is a Mutual Fund? Investors pool their money A fund manager buys a variety of stocks Each investor owns a share of the fund (the total of all the stocks in the fund) When the fund increases in value, the investor makes money

How Mutual Funds Work Individual Investor Mutual Fund Individual The mutual fund invests in a wide range of stocks and bonds Individual Investor Individual Investor Individual Investor Individual Investor

Net Asset Value Mutual funds do not change price throughout the trading day The price you buy and sell for is called net asset value (NAV) rather than stock price It is updated only once a day, at the end of the trading day NAV equals Total value of securities minus debts divided by number of shares

Open-Ended Funds This type of fund may issue as many shares as it wishes, and anyone can invest 95% of funds are open-ended

Closed-End Funds Closed-end funds can issue a limited number of shares Investors buy and sell shares among themselves

Advantages of Mutual Funds Diversification You purchase a small amount of many stocks without having to physically buy each stock Professional Management Fund managers are professionals with access to better information than the average investor

Advantages of Mutual Funds Minimal transaction costs Individual investors save on brokerage fees compared to individual stock purchases. In a retirement account there is a delay in state and federal income taxes. Liquidity Easy to buy and sell Flexibility There are over 8000 funds to choose from, allowing you to invest in an area you want

Disadvantages of Mutual Funds Lower-than-market performance On average, mutual funds underperform the market Costs May charge a sales fee as well as an annual expense fee that will eat away your profits

Disadvantages of Mutual Funds Risk Depending on the segment of the market the mutual fund invests, it may do very well or very poorly Systemic Risk A market crash will have a negative effect on your fund

Disadvantages of Mutual Funds Fees: “Load” funds charge a commission to buy or sell the funds Usually 4-8% of the investment “Front-end load” means you pay a commission when you buy “Back-end load” means you pay a commission when you sell the fund

Disadvantages of Mutual Funds “No-load” funds mean you don’t pay a sales commission, but deal directly through the investment company Some funds will charge a fee if you sell within a specific period of time, such as 90 days

Disadvantages of Mutual Funds Owners of mutual funds pay an annual expense Known as the expense ratio Typically it is .25 to 2 percent of the investment value Try to buy a fund with the lowest expense ratio possible Expenses can eat up all or most of your profits, especially if the fund isn’t performing well

Costs of Mutual Funds Taxes 12b-1 fee You have to pay taxes on gains as you go, except in a retirement account 12b-1 fee These are marketing expenses passed on to the investor They do not benefit the investor at all Try to find funds that have minimum or no 12b-1 fees They will eat into your profits and do not provide any benefit to the investor

Types of Mutual Funds Stock funds Most popular types of funds They buy mostly stocks, but may also invest in cash, bonds, and money market funds

Types of Stock Funds Aggressive Growth Funds The fund buys stocks that will (hopefully) increase dramatically in price Very volatile Small-Company Growth Funds Investments are limited to small companies Volatile

Types of Stock Funds Income Funds Growth-and-Income Funds Concentrate more on strong companies paying dividends Less risky than aggressive growth funds Growth-and-Income Funds Concentrate on stocks providing dividends plus the potential for growth Less volatile

Types of Stock Funds Sector Funds International Specializes in stocks from a specific industry Computer, financial services, biotech, etc. International Invests mostly in stocks outside the U.S.

Types of Mutual Funds Balanced Funds Asset Allocation Holds both stocks and bonds Asset Allocation Balanced funds with market timing Life Cycle Funds (relatively new) Attempt to tailor holdings to the investor’s age and risk tolerance The fund is managed based on how close you are to retirement

Types of Mutual Funds Bond funds Invest in bonds rather than stocks Emphasize income over growth Types of bond fund (remember that a bond is debt (I.O.U. or loan) issued by a company or government that must be paid back) U.S. Government bonds Municipal bonds (bonds issued by city or state) Corporate bonds

Index Funds or ETF’s These funds track a market index such as the S & P 500, the DOW, or the Nasdaq S&P 500 – SPDRS NASDAQ – QQQ Dow Jones – IYY They have a low expense ratio Inverse index funds will directly mirror the opposite of the market index.

ETFs (Exchange Traded Funds) These are a hybrid between mutual funds and stocks They trade like a stock on an exchange They represent a basket of stocks that reflect the overall performance of the market. The biggest are IYY (Dow Jones), QQQ (Nasdaq) and SPDRS (tracking the S & P 500) They help you achieve overall diversification.

Inverse ETF's There are also Inverse ETF's which will make you money when the market index declines (Bear Market). However, you will lose money when the market index rises (Bull Market).

Buying a Mutual Fund Determine your goals Meeting your objectives What are you investing for? Retirement Education Income Growth Meeting your objectives Make sure the fund meets your goals (above)

Evaluate the Fund www.morningstar.com identifies funds by investment strategy and management style Look closely at past performance and expenses Compare funds in the same category; do not compare a growth fund to an international fund, for example Look for “star” ratings (4-star and 5-star ratings)

Buying a Mutual Fund You can purchase through your company’s 401(k) website You can purchase directly from the mutual fund company You can purchase from your broker You can purchase through your bank Many funds will let you invest with as little as $250 in a retirement account

Alternatives for a Retirement Program 401 K Plan – This is an employer-sponsored retirement plan that is limited to a maximum yearly contribution of $16,000 for employees under the age of 50, and $24,000 for employees over 50. The total maximum contribution, including the employer contribution is $53,000. Traditional IRA – Individual Retirement Account. Similar to a 401 K Plan, this allows individuals to set aside pre-tax income for future use in retirement to either supplement a 401 K, or replace the same. Roth IRA – This allows an individual to set aside a portion of their after-tax income for future use in retirement. SEP – Simplified Employee Pension. Employers can contribute up to 15% of an employees salary, or $30,000, whichever is less. The employee can’t make contributions into an SEP. SIMPLE – Savings Incentive Match Plan for Employees. You can put in $6,000 in, and you can still contribute into an IRA. Profit-sharing Plan – The employer may contribute 15% of an employees net salary up to $160,000.