Chapter 15 Investing Through Mutual Funds

Copyright © Houghton Mifflin Company. All rights reserved.15 | 2 Learning Objectives 1.Describe the features, services, and advantages of investing in mutual funds. 2.Differentiate mutual funds by investment objectives, types, and characteristics. 3.Summarize the fees and charges involved in buying and selling mutual funds. 4.Establish strategies to evaluate and select mutual funds that meet your investment goals.

Copyright © Houghton Mifflin Company. All rights reserved.15 | 3 Why Invest in Mutual Funds? Mutual funds pool the invested funds of many investors and use them to invest in a diversified portfolio. Net Asset Value (or NAV): Per-share value of a mutual fund. –Assets of the fund less its liabilities –Divided by the number of shares outstanding Dividend income and capital gains –Ordinary income dividend distributions –Capital gains distributions

Copyright © Houghton Mifflin Company. All rights reserved.15 | 4 How a Mutual Fund Works Most 401(k) plans invest in shares of mutual funds

Copyright © Houghton Mifflin Company. All rights reserved.15 | 5 Sources of Investor Returns from Owning Mutual Fund Shares >

Copyright © Houghton Mifflin Company. All rights reserved.15 | 6 Advantages of Investing Through Mutual Funds Diversification –Random (or nonsystematic) risk Affordability Professional management –Fund investment advisers Liquidity Low transaction costs Uncomplicated investment choices

Copyright © Houghton Mifflin Company. All rights reserved.15 | 7 Mutual Fund Services Convenience Ease of buying and selling shares Check writing and electronic transfers Distribution or automatic reinvestment of income and capital Telephone and internet exchange privileges –Exchange (or switching, conversion, or transfer) privilege Beneficiary designation Automatic investment

Copyright © Houghton Mifflin Company. All rights reserved.15 | 8 The Wisdom of Automatic Dividend Reinvestment

Copyright © Houghton Mifflin Company. All rights reserved.15 | 9 Types of Investment Companies Closed-End Mutual Fund – issue a limited and fixed number of shares and issuer does not buy them back. Real Estate Investment Trust (or REIT) – Investments made in assets such as properties, offices, shopping centers or mortgages. No predetermined life span Unit Investment Trust (or UIT) – one time public offering for a fixed maturity security such as a municipal bond. Each unit is a proportionate ownership interest in the specific portfolio. Exchange-Traded Fund (or ETF) – Passively managed securities like an index fund which owns all or a set amount of securities that duplicate the performance of a market segment such as the S&P 500, Dow Jones, etc.

Copyright © Houghton Mifflin Company. All rights reserved.15 | 10 Fund Objectives, Types, and Characteristics Managed Funds – A professional manager with oversight who constantly evaluates and chooses securities to buy or sell using a specific investment approach. Income Objective – Invests in securities that pay regular income in dividends or interest.

Copyright © Houghton Mifflin Company. All rights reserved.15 | 11 Fund Objectives, Types, and Characteristics Money Market Funds –Tax-exempt money market funds – municipal securities with maturities of 90 days or less –Government securities money market funds – Appeal to investors who prefer safety by investing exclusively in U.S. Treasury bills and other short term securities. Bond funds –Bond (or fixed-income) funds – Goal of earning income higher than a money market fund without incurring undue risk by investing in a portfolio of bonds as well as some preferred stock and common stock that pay high dividends.

Copyright © Houghton Mifflin Company. All rights reserved.15 | 12 Fund Objectives, Types, and Characteristics Growth objective –Aggressive growth (or maximum capital gains) funds – seek the greatest long-term capital appreciation. Investments made in speculative stocks with volatile price swings. –Growth funds – long term growth by investing in common stocks of companies with higher than average revenue and earnings growth. Large, well established firms. –Growth and income funds – A balanced return made up of current income and capital gains appreciation. Companies who expect average or better growth and pay steady or rising dividends. –Value funds – Stocks whose prices appear to be low (low P/E) and undervalued –Sector funds – Concentrate holdings in one or more industries that make up a targeted part of the economy expected to grow.

Copyright © Houghton Mifflin Company. All rights reserved.15 | 13 Fund Objectives, Types, and Characteristics Index Funds: These funds are unmanaged. Growth and income objective –Growth and income funds – Companies which expect average or better growth and pay steady or rising dividends. –Equity-income funds - Well-known companies with long history of paying high dividends with emphasis on income and capital preservation –Socially conscious funds – environmental or community involvement organizations that promote moral or ethical behavior. –Asset allocation funds – asset allocation based upon mix of risk tolerance (aggressive, moderate, conservative) –Life-cycle funds - Shift allocation based upon change in risk tolerance due to age.

Copyright © Houghton Mifflin Company. All rights reserved.15 | 14 Fees and Charges of Mutual Fund Investing Shareholder Fees – occur per transaction such as purchase, redemption or exchanges. Annual Fund Operating Expenses – operating costs that are deducted from fund assets before earnings are distributed to shareholders.

Copyright © Houghton Mifflin Company. All rights reserved.15 | 15 Load and No-Load Funds Load funds always charge transaction fees. –Front-end load – Sales charge paid when an individual buys an investment reducing the amount available to purchase fund shares. (Max 8.5% permitted by SEC) –Stated commission – percent of commission charged. –Percentage of the amount invested – actual percent based upon net amount available for investment Some no-load mutual funds assess 12b-1 fees. –12b-1 (or distribution) fee – assessed annually to compensate underwriters and brokers for fund sales and to compensate for marketing and advertising expenses and range from 0.75% to 1 %

Copyright © Houghton Mifflin Company. All rights reserved.15 | 16 Load and No-Load Funds Some no-load funds assess deferred load and redemption fees. –Deferred (or back-end) load – Sales commission imposed only when shares are sold. Charges are on a sliding scale with the fee dropping 1% per year the investor remains in the fund. –Redemption charge (or exit fee) – used to reduce excessive trading of fund shares.

Copyright © Houghton Mifflin Company. All rights reserved.15 | 17 Process of Selecting Mutual Fund Investments

Copyright © Houghton Mifflin Company. All rights reserved.15 | 18 Selecting Funds in Which to Invest Screen and compare funds that meet your investment criteria. –Fund screener (or fund screening tool) – – – –Profile prospectus (or fund profile) – describes mutual fund, its investment objectives and how it achieves its objectives. –The prospectus includes a standardized expense table which describes the effects of all fees and expenses. –Note the expense ratio which is the expense per dollar of assets under management. Avg. is 1.45% for diversified stock funds and 0.25% for index funds. Monitor your mutual fund portfolio. – use of the internet or newspapers is a good source

Copyright © Houghton Mifflin Company. All rights reserved.15 | 19 Balancing Risk and Returns on Mutual Funds

Copyright © Houghton Mifflin Company. All rights reserved.15 | 20 How Mutual Funds Are Quoted

Copyright © Houghton Mifflin Company. All rights reserved.15 | 21 How Mutual Funds Are Monitored

Copyright © Houghton Mifflin Company. All rights reserved.15 | 22 The Top 3 Financial Missteps In Mutual Fund Investing People experience challenges in mutual fund investing when they do the following: 1.Buy funds with high fees and expenses. 2.Withdraw dividends rather than reinvesting. 3.Chase performance by investing in “hot” funds.

Copyright © Houghton Mifflin Company. All rights reserved.15 | 23 Good Money Habits in Mutual Funds Match your investment philosophy and financial goals to a mutual fund’s objectives. Invest only in no-load mutual funds that have low expenses Get the right mix of asset classes in your long-term fund investments and learn to love consistency. Sign up for automatic reinvestment of your mutual fund dividends. Invest regularly through your employer’s retirement plan. Rebalance your portfolio at least once a year and dump the slackers.