Investing Through Mutual Funds

Objectives Identify why people invest in mutual funds. Distinguish among the four major objectives of mutual funds. Classify mutual funds by portfolio. List the unique benefits of mutual funds.

Objectives Describe the various charges and fees associated with investing in mutual funds. Explain how to select a mutual fund in which to invest. Recognize valid reasons for selling a mutual fund investment.

Investing Through Mutual Funds open-end investment company combining funds of investors who have purchased shares in a diversified portfolio of securities.

What is a Mutual Fund? A pool of money Managed by a professional investor Manager works for an investment firm Each fund has a specific objective Over 6,000 funds to choose from

Mutual Funds

Three Reasons Why People Purchase Mutual Funds Diversification funds of many investors are pooled and used to purchase a variety of investments Professional management who is the fund’s manager? managers can change Convenience phone mail 16-3

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

Reasons for Investing Through Mutual Funds New/more types of funds Few or no sales charges Some performed better than common stock Widespread marketing Selection is easier

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

Exchange-Traded Funds Invests in the stocks contained in a specific stock market index, like the Standard and Poor’s 500 stock index. Performance of shares in the fund tend to mirror the performance of the index. Low management fees since there is less need for decisions made by a portfolio manager. 16-6

Reasons for Investing Through Mutual Funds Dispense profits to investors Investors expect dividend income Investors expect price appreciation

Closed and Open End Funds Closed end fund (10% of funds) limited number of shares issued initially then can only purchase shares from another investor willing to sell theirs Open end fund (90% of funds) no limitations on the number of shares the investment company can issue shares are issued and redeemed by the investment company

Net Asset Value portfolio market value - liabilities the number of shares outstanding Offer price = NAV + sales commission

Objectives of Mutual Funds Current income Long-term growth Growth and income Balanced

Classification of Mutual Funds Common stock Balanced Bond Specialty Money market

Unique Benefits of Mutual Funds Recordkeeping/reporting Easy purchase and sale Automatic reinvestment IRS-qualified tax-sheltered retirement Withdrawal plans Collateral for loans

Costs of Investing Through Mutual Funds Management fees Loan funds No-load funds

Costs of Investing Through Mutual Funds Hidden fees Deferred load Redemption 12b-1 Disclosure of Fees “Which is better, load or no-load?”

Load vs. No Load Funds Load Fund pay a commission to a sales agent when you buy shares usually 3-8% No Load Fund no sales charge paid purchased directly from the investment company usually have an 800 number you can call

Management Fees and Other Charges Contingent deferred sales load (back-end load) (Class B shares). 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. 12b-1 fees (Class C shares). Annual fee to defray advertising and marketing costs of the fund. 1% or less of a fund’s assets per year. 16-9

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. 16-11

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. 16-12

Classification of Mutual Funds (continued) 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). 16-13

Classification of Mutual Funds (continued) 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. 16-14

Classification of Mutual Funds (continued) 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. 16-15

Strategies for Selecting a Mutual Fund Match goals Locate sources of comparative performance data Financial press (i.e. Wall Street Journal, Barron’s) Magazines (i.e. Fortune, Kiplinger’s) Specialized mutual fund publications

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. 16-16

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 invest. A fund’s objective should match your investment objective. Evaluate any mutual fund before buying or selling (www.morningstar.com) Consider managed funds vs. indexed funds 16-17

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. 16-20

Mutual Fund Transactions You can open an account from $250 to $3,000 and up depending on the fund & family. 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. 16-22

When To Sell Fund performs poorly compared with similar funds Perception of economic trends indicates business cycle will smooth out soon Fund grows too rapidly or becomes too large Fund taken over by new manager Investment goals become more conservative Need cash