XV. MUTUAL FUNDS

The Five Things to Know Before Investing in Mutual Funds 1.What is the fund sponsor’s reputation for: a.Leadership b.Clarity of Communication c.Transparency, and d.Business Continuity; 2.What is the tenure and experience of fund managers; 3.What is the fund’s style; 4.What is the fund’s expense ratio, and 5.Has the fund provided consistently strong returns relative to its peers?

A. The Mechanics of Mutual Funds 1.Mutual funds pool money from many investors 2.Mutual fund investors own a part of all of the securities in the mutual fund “pool” 3.The fund manager is responsible for tracking the securities in the pool 4.Mutual funds provide diversification – mutual fund investors can own a portion of a variety of stocks and/or bonds for a relatively small investment

A. The Mechanics of Mutual Funds 5.Profits are paid in two ways: a.Income Distributions – Dividends and interest paid by the underlying securities are subsequently paid to investors b.Capital Gains Distributions – Payment to investors of profits obtained from sales of securities 6.Passive Funds – Primarily index funds 7.Active Funds – Run by a professional manager – active funds have : a.Professional managers b.An investment objective, and c.An investment program designed to meet the investment objective

A. The Mechanics of Mutual Funds 7.Open and Closed End Funds a.Open end – sold by brokerage firms and by fund distributors, issues or purchases shares depending upon demand, uses client funds to buy or sell securities b.Closed end – raise money only once, invest in a variety of securities, and offer a fixed number of shares – traded Over the Counter or on the market – price varies with the price of the underlying securities and with market demand (discount or premium from Net Asset Value)

B. TYPES OF MUTUAL FUNDS 1.Stock Funds – invest in equity securities, can be growth, value, dividend, sector, market cap, etc. 2.Bond Funds – invest in Treasury bonds, municipal bonds, passive trading of securities, active trading of securities, high yield bonds, corporate bonds, etc. 3.Commodity Funds – invest in stocks of commodities firms or in commodity futures 4.Balanced Funds – contain a mix of stocks and bonds (generally 60% stocks, 40% bonds)

B. TYPES OF MUTUAL FUNDS 5.Target Date Funds – change investment allocation as a target date approaches (ex. - §529 funds) 529 funds529 funds 6.Money Market Funds – cash equivalent securities – like a savings account 7.International Funds – invest in Europe, China, Asia, Far East, Latin America, emerging markets, etc. 8.Miscellaneous – socially responsible funds, sin funds, green funds, etc.

C. DEFINITIONS 1.Turnover Rate – the number of times per year that the equivalent of all of the underlying securities in the fund are purchased or sold 2.Volatility – the historic deviation of rates of return above and below the average rate of return 3.Prospectus – similar to a stock prospectus, explains fund objectives, investment strategy, fees, historic before and after tax returns, and fund risk profile

C. DEFINITIONS 4.Net Asset Value (NAV) – the value of the underlying securities in a fund - defined as: (market cap of fund shares + accrued interest + accrued dividends – accrued expenses) number of fund shares number of fund shares 5.Premium – The price of a share of a closed end mutual fund minus the share Net Asset Value – exists where demand for fund shares exceeds the value of the underlying holdings

C. DEFINITIONS 6.Discount – Where the shares of a closed end fund trade below the fund’s net asset value, exists where demand is less than the value of the underlying holdings 7.Liquidity – The ability to get “into” and “out of” an investment (buy and sell) – ETFs are generally highly liquid, mutual funds are not 8.Diversification – Where a fund holds a variety of securities 9.Fund Objectives – the management style behind a mutual fund (large cap, small cap, growth, value, junk bond, muni, etc.)

C. DEFINITIONS 10.Rating – An independent analyst’s opinion of how the fund has performed compared to benchmarks 11.Ranking – The relative standing of a mutual fund compared to others with similar investment strategies 12.Sharpe Ratio – Calculated as a fund’s rate of return – the rate of return on 3 month Treasury bills divided by the standard deviation of fund returns Sharpe Ratio = (Fund Return – 3 mo. Treasury Yield) Standard Deviation of Fund Returns

C. DEFINITIONS 13.Standard Deviation – The amount by which the annual returns of a fund vary above and below the fund’s average return 14.Rating Firms: a.Standard and Poors Standard and PoorsStandard and Poors b.Morningstar Morningstar c.Lipper Lipper

C. DEFINITIONS 15.Fund Style (See Style Box) See Style BoxSee Style Box a.Growth/Blend/Value – Invests in growth stocks, a blend of growth and value stocks, and value stocks b.Small Cap (less than $1.5 billion), Mid Cap ($1.5 billion to $9 billion), Large Cap ($9 billion +) c.Dividend (Yield) – Invests in securities with the highest dividend payments d.Contrarian – Against the accepted (current trend) in management e.Style Drift – When a fund manager changes styles to make up for below market returns 16.Portfolio Overlap – Where a holder of several mutual funds owns duplicate underlying shares of stock

D. FEES AND CHARGES Fees have the greatest impact on fund returns other than the manager’s performance 1.Sales Charges (Loads) a.Front End Load – A sales charge on fund purchase, reduces the number of shares purchased b.Back End Load (Redemption Fee or Contingent Deferred Sales Charge) – Paid when shares are sold – usually declines to 0 after 5-7 years – designed to prevent investor “churn” c.Level Load – sales charges are part of annual operating expenses

D. FEES AND CHARGES 2.Fund Classes a.A = Front end load b.B = Back end load c.C = Level load – no sales charges, but higher fees than A or B – higher annual fees and charges instead of front end or back end loads 3.Exchange Fees – A charge for moving assets between different funds issued by the same group

D. FEES AND CHARGES 4.Early Redemption Charge – Exit fee, can be 5 days to 1 year 5.Breakpoint – A point where more money is invested to reduce the front end load a.Right of Accumulation – Where an investor can combine past and new investments to reach a breakpoint b.Letter of Intent – A promise by the investor to increase the amount invested to reach a breakpoint

D. FEES AND CHARGES 6.Other Types of Fees – Total annual fees are quoted as an “Expense Ratio” – must be listed in the fund prospectus, generally range from 0.1% to 2.75% a.12-b 1 Fees – Marketing and distribution expenses – limited by NASD rule to 1% of assets per year or less, with marketing fees at 0.75% or less; and with shareholder services capped at 0.25% of assets b.Management Fees – Charge to pay the advisory firm that invests fund assets

The Securities and Exchange Commission (SEC) maintains a mutual fund fee calculator to assist consumers - seesee FINRA also has a tool for analyzing mutual funds, including fees - seesee

E. MEASURING FUND RETURNS 1.Percentage change in share price (market value) is the measure of fund returns for closed end funds Percentage Closing Share Price Rate of Return= Opening Share Price -1

E. MEASURING FUND RETURNS 2.Net Asset Value = Value of Fund Investments Number of Shares Number of Shares Percentage Closing Net Asset Value Change in NAV = Opening Net Asset Value -1

E. MEASURING FUND RETURNS 3.Distributions – Can be both interest (dividends and interest on investments) and capital gains (mutual fund’s gain from sale of underlying investments) 4.Yield = Distribution per Share Price per Share

E. MEASURING FUND RETURNS 5.Total Return = Change in NAV + Distributions Cost of Initial Investment a.Reported as a geometric mean, taking into account annual compounding of distributions b.Must be viewed in comparison with standard indices or with indices of competing funds with a similar investing style

F. ANNUITIES 1.Defined as an investment contract between the purchaser and an insurance company, funded (money invested) either by a lump sum or by a series of scheduled payments 2.Types of Annuities a.Fixed annuities – interest rate set upon purchase b.Variable annuities – contain a selection of sub accounts, with the yield on the annuity varying depending upon the investment performance of the types of securities represented in the sub account

F. ANNUITIES 3.Advantages of annuities over mutual funds a.Income taxes – no income taxes are paid on capital gains until the annuity matures (presumably when the investor is retired and in a lower tax bracket) b.Withdrawals from an annuity, unlike withdrawals from a pension plan or an IRA, can be postponed until after age 701/2, allowing transfer of wealth to heirs

F. ANNUITIES c.Special types of annuities (ex. §403(B) annuities) are tax deferred for both contributions and interest d.Annuities may contain a death benefit, which is a guaranteed payment upon death regardless of market conditions – the death benefit is similar to life insurance, funded by a mortality and expense (M&E) fee.

F. ANNUITIES 4.Disadvantages of annuities a.Annual fees are generally higher than mutual fund annual fees as a percentage of the amount invested b.Surrender fees – a back end load, generally starting at 7% for the first year, declining by 1% per year thereafter

F. ANNUITIES 5.Annuity ratings a.As an insurance product, the state of issue may guarantee the company’s obligations, including annuities, in the event that the company becomes insolvent (goes bankrupt) b.The insurance companies issuing annuities are rated by Standard and Poors and Morningstar