1. Topic 20–Mutual Funds Lawrence Schrenk, Instructor
FIN 200: Personal Finance
Topic 20–Mutual Funds
Lawrence Schrenk, Instructor

2. Learning Objectives Define a mutual fund. ▪
Outline the main types of funds.
Describe the returns from and costs of a mutual fund. ▪

3. Mutual Funds: Overview

4. What and Why? What is a mutual fund? Why were they developed?
Investment company that pools money
Investors own a proportionate share of the fund to the amount of their investment divided by the total value of the fund
Why were they developed?
To give smaller investors access to professional management and to increase the assets of mutual fund companies

5. Advantages of Mutual Funds
Diversification
Full-Time Professional Management
Modest Capital Investment
Minimal Transaction Costs
Services Offered
Convenience/Liquidity

6. Disadvantages of Mutual Funds
Lack of Liquidity
Normally must be sold back to the fund
Average to below average performance
Average Annual Returns
Actively managed stock funds 15.6%
S&P 500 stock index 19.2%.
Fees and taxes can take a significant part of investor returns

7. Disadvantages of Mutual Funds
Percentage of Actively Management Funds that failed to beat their benchmarks
Source: John Bogle, Common Sense on Mutual Funds: New Imperative for the Intelligent Investor, John Wiley & Sons, USA, 1999, p. 119)

8. Mutual Funds: Types

9. Number of Mutual Funds by Type

10. Major Types of Mutual Funds
Major Asset Classes
Money Market Funds
Stock Funds
Bond Funds
Specialty Funds
Index Funds
Exchange Traded Funds (ETFs)
Balanced Funds
Etc.

11. Stock Funds: Payout Approach
Income Funds
Goal: Current income
Dividend income
Growth Funds
Goal: Capital Appreciation
Higher-than-average revenue/earnings growth
Aggressive/Maximum Growth Funds
Goal: Extreme Capital Appreciation
Highly speculative, seeking large profits from capital gains
Often buy stocks of small, untested companies

12. Stock Funds: Geographic Approach
Domestic Funds
U.S. Equities Only
Global Funds
U.S. and International Equities
International Funds
International Equities Only
Country/Regional Funds
Specific Country/Region of the World

13. Stock Funds: Firm Size Large-Cap(italization) Funds
Capitalization $5 billion or more
Mid-Cap(italization) Funds
Capitalization between $1 and $5 billion
Small-Cap(italization) Funds
Capitalization $1 billion or less

14. Stock Funds: Other Sector Funds Socially Responsible Funds Index Funds
Particular industry such as biotechnology.
Socially Responsible Funds
Companies that don’t produce harmful products.
Index Funds
Mirror an index, like the S&P 500

15. Bond Funds: Yield High-Yield (Junk) Bond Funds Index Bond Funds
Corporate bonds that are higher risk and higher yield.
Index Bond Funds
Sampling of bonds included in an index.

16. Bond Funds: Maturity Long Term Bond Funds Intermediate Term Bond Funds
Maturities > 10 Years
Intermediate Term Bond Funds
Maturities 5-10 Years
Short Term Bond Funds
Maturities 1-5 Years
Note: Can be either Government or Corporate Bond Funds

17. Bond Funds: Issuer Corporate Bond Funds Treasury Bond Funds
Municipal Bond Funds
International Bond Funds

18. Asset Allocation Funds
Various asset classes, such as stocks, and bonds, with precise amounts within each type
Rotate among stocks, bonds, and cash
Goal: Invest in the asset classes expected to perform the best over the coming period of time (‘Timing’)

19. Balanced Funds Goal: Balance between Capital Gains and Current Income
Stocks and bonds
High-Grade Common Stocks (60-75%)
Fixed Income Securities (25-40%)

20. Mutual Funds: Other Money Market Funds
Goal: Higher return (after fees and expenses) than traditional bank savings or checking accounts
Short-term liquid financial instruments such as commercial paper and government treasury bills
Access to high-yielding money market instruments without having to pay $100,000 denominations

21. Mutual Funds: Other Single Industry Specialty Funds Option Trading
Commodity Funds
Oil Drilling
Cattle Funds
Electronics
Gold
Chemicals
Health

22. Life-Cycle Funds
Change allocation depending on the age of the investor.
Reduce their allocation to stocks and increase their allocation to bonds
These funds seek to perform the asset allocation decision normally done by the investor and to reduce transaction costs as well.

23. Mutual Funds: Returns and Costs

24. Mutual Fund Returns Capital Gains Distributions
Market Value Appreciation
Capital gains at the share level are not taxed until you sell your mutual fund shares.
Distributions
Interest, dividends, realized capital gains, etc.
Taxable even if you do not sell any mutual fund shares

25. Mutual Fund Returns: Types
Qualified Stock Dividends
Short-Term Capital Gains
Long-Term Capital Gains
Bond Dividends and Interest

26. Costs of Mutual Funds Explicit Costs Management Fees 12b-1 Fees
Charged by the Advisor
Percentage of average assets, e.g. .75%
12b-1 Fees
To cover cost of advertising and marketing
Total Expense Ratio
Fees as total percentage of assets
Custody (or Annual) Fees
Brokerage house charges to hold mutual funds

27. Costs of Mutual Funds Implicit Costs: Taxes on Distributions
Stock Dividends
15% or 5%.
Short-Term Capital Gains
Marginal Tax Rate
Long-Term Capital Gains
Bond Dividends and Interest:

28. Costs of Mutual Funds Hidden Costs: Transaction Costs
Costs of the fund buying and selling securities not included in other costs
A good measure this is the turnover ratio, a measure of trading activity during the period divided by the fund’s average net assets.
A turnover ratio of 50% means half the fund was bought and sold during the period
Turnover costs money and incurs taxes

29. Costs of Mutual Funds Other Hidden Costs: Account Transfer Fees
Charges for moving assets either into our out of an existing account
Account Maintenance Fees
Fees for maintaining your account
Inactivity/Minimum Balance Fees
Fees because you did not trade or failed to keep a minimum balance in your account

30. Front-, Back- and No Load Funds
Front-Load Funds
Commissions charged when purchasing shares.
Investors pay a commission (sales charge) up to 8.5% every time they purchase shares. This is sometimes called a front load. (Class A shares)
Average charge is 3-5% for which an investor can get purchase advice and explanations.

31. Front-, Back- and No Load Funds
Back-Load Funds
Commissions charged when selling shares.
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.
No-Load Funds
Investors pay no sales charge up front.
You deal directly with the fund with 800 numbers or web sites, or from discount brokers.

32. Open- versus Closed-End Funds
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).
Closed-End Funds (7% of Funds).
Shares are issued only when the fund is organized.
Only purchase shares only from another investor.
Traded on exchanges and over-the-counter.
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33. Open-End Funds Investors buy and sell shares back to the fund itself
There is no limit on the number of shares the fund can issue
Net Asset Value (NAV)
Defined as the total market value of all securities held by the fund less liabilities, divided by the number of fund shares outstanding.

34. Net Asset Value (NAV)
For most mutual funds, NAV is calculated at the close of trading each day.
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35. Net Asset Value Example
Example: NAV
XYZ Mutual Fund owns assets totaling $10M and liabilities equal to $500,000 with 500,000 shares outstanding.

36. Closed-End Funds Closed-End Funds Investment Trusts
A fixed number of shares outstanding
100 Closed-end funds
$8 billion market value
Investment Trusts
Interest is an unmanaged pool of investments
Usually consist of corporate, government, or municipal bonds

37. Mutual Fund Prospectus
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.
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38. Mutual Fund Quotations
Net asset value and asset value change.
The fund family and fund name.
Fund objective.
Total return over various time periods.
Ranking among funds with the same objective.
Sales load fees if any, or no load (NL).
Annual expenses.
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39. Mutual Fund Quotation Example

40. Project Note

41. Ethical Dilemma