1. Investing in Mutual Funds, Real Estate, and Other Choices Chapter 14

2. Lesson 14.1: Investing in Mutual Funds What are mutual funds Advantages of mutual funds Mutual fund risk/return categories Mutual funds of various risk categories Evaluating mutual funds

3. What are Mutual Funds?? Mutual fund – professionally managed group of investments bought using a pool of money from many investors Family of funds – a variety of funds covering a wide range of investment objectives (aggressive growth stocks, bond funds, money-market securities)

4. What are Mutual Funds?? Earnings –Investors share in mutual fund profits –Professional managers buy and sell according to market conditions, trends, etc. –Receive dividends and capital gains May be reinvested or distributed in cash to investor

5. What are Mutual Funds?? Initial investment ranges from $500 to $3,000 or more Additional investments can be made at any time Withdrawals can easily be made

6. Advantages of Mutual Funds Convenience of professional management Mutual funds are liquid – can be quickly converted to cash and withdrawn Diversification – mutual funds purchase a variety of stocks and bonds Small minimum investment

7. Mutual Fund Risk/Return Categories Growth fund – investment goal is to buy stocks that will increase in value over time –Invests in companies that reinvest profits in company rather than pay dividends –Earnings through capital gains vs. dividends –Aggressive growth fund – new or out-of-favor companies or industries

8. Mutual Fund Risk/Return Categories Income fund – investment goal is to buy bonds that produce current income in the form of interest –Investors are looking for income now vs. capital gain later –May specialize in tax-exempt bonds to appeal to investors in high tax brackets

9. Mutual Fund Risk/Return Categories Growth and income funds – investment goal is to earn returns from both dividends and capital gains –Balanced fund – similar to growth/income funds, but invests in stocks and bonds to minimize risk

10. Mutual Fund Risk/Return Categories Money market fund – invests in safe, liquid securities (treasury bills and treasury bonds) –Goal is the preservation of principal with very high liquidity Mutual Fund Risk/Return Pyramid, figure 14-1, p. 327

11. Mutual Funds of Various Risk Categories Global funds – purchases international and U.S. stocks and bonds –Risk varies by investment objective –Additional risk in currency exchange rates and political instability Index funds – attempts to match performance of a particular index by investing in companies in that index –Risk varies based on index (Dow Jones – low risk; NASDAQ – high risk)

12. Evaluating Mutual Funds Based on investment objectives and risk tolerance –Income now vs. later –Tax free or tax-deferred investments –Risky (high return) vs. safer (low return) Net Asset Value (NAV) – value of portfolio minus its liabilities divided by outstanding shares

13. Evaluating Mutual Funds Prospectus – legal document that offers securities or mutual fund shares for sale –Must be provided by law –Must include: Terms Summary of investments Objectives Financial statements showing past performance

14. Evaluating Mutual Funds Costs and fees –Load – sales fee (ranges from 2% - 8%) Front-end load – sales charge paid when investment is purchased Back-end load – sales charge paid when investment is sold No-load fund – no sales charge; buy directly from investment company without salesperson –Annual management fee – 1% - 1.5% –12b-1 fee – offsets marketing costs and costs to distribute mutual funds –Expense ratio – includes all fees associated with fund

15. Evaluating Mutual Funds Print and online sources of mutual fund information –Financial publications (Forbes, Fortune, and Money) Compare 1, 5, and 10 year performances Show expense ratios –Online Search by fund families (Vanguard, Fidelity, and Dreyfus) Mutual Fund Investors Center (www.mfea.com) – educational information on mutual funds www.mfea.com

16. Lesson 14.2: Investing in Real Estate and Other Choices Direct real estate investments Indirect real estate investments Owning and managing rental property Investing in metals, gems, and collectibles Investing in financial instruments

17. Direct Real Estate Investments Real estate – land and any buildings located on it Commercial real estate – land and buildings that produce lease or rental income (office buildings, stores, hotels, and duplexes and multi-unit apartments) Value of real estate increases over time, but is illiquid (not easily converted to cash) Direct real estate investment – investor holds legal title

18. Direct Real Estate Investments Vacant land – unimproved property –Speculative, risky Single-family houses – purchase a home and rent it to others –Financing requires larger downpayment –Must provide running water, electricity, sewer or septic hookups –Responsible for normal repairs and maintenance

19. Direct Real Estate Investments Duplex – building with 2 separate living quarters Condominium – individually owned unit in an apartment style complex –Monthly maintenance fee (mowing lawn, maintaining swimming pool, snow removal, etc.) –Appeal to singles, young adults, childless couples, retirees

20. Direct Real Estate Investments Recreation and retirement property –Second homes – may be rented when not in use –Must arrange for care of property (real estate companies)

21. Indirect Real Estate Investments Several different investors own the property and appoint a trustee to hold legal title Trustee – individual or institution that manages assets for others

22. Indirect Real Estate Investments Real estate investment trust (REIT) – corporation that pools money from many individuals to invest in real estate (similar to mutual fund) –REIT makes all buy and sell decisions –Shares can be bought or sold at any time –Dividends are paid

23. Owning and Managing Rental Property Mortgage – a loan to purchase real estate Leverage – borrowing money to purchase an investment Equity – ownership interest (difference between market value and mortgage balance) Positive cash flow – if money is left after mortgage and other expenses (taxes, insurance, and maintenance) are paid from rental income Negative cash flow – if mortgage and other expenses cannot be covered with rental income

24. Owning and Managing Rental Property Depreciation – decline in property value due to normal wear and tear –Reduces taxable income along with taxes, insurance, and other expenses of maintaining the property If property increases in value, must pay capital gain tax when property is sold

25. Owning and Managing Rental Property Disadvantages –Renters can damage or destroy property –Renters can default on making rent payments –Extended periods of vacancies will reduce rental income

26. Investing in Metals, Gems, and Collectibles Speculative investing – can return large profits or large losses –Easy to purchase –Difficult to sell quickly –Provide no income in the form of interest or dividends

27. Investing in Metals, Gems, and Collectibles Precious metals – gold, silver, platinum –Prices swing widely over time Gems – natural precious stones (diamonds, rubies, sapphires, and emeralds) –Prices are subject to drastic change Market to resell is small and unpredictable

28. Investing in Financial Instruments Futures – contracts to buy and sell investments for a specified price on a specified date in the future. –Commodities – farm products (wheat, corn, cattle, etc.) Option – the right, but not obligation, to buy or sell an investment for a specified price within a specified time period –Call option – the right to buy a stock at a set price –Put option – the right to sell a stock at a set price