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C HAPTER 16

C HAPTER 16. Investing in Mutual Funds. Personal Finance. 7e. Kapoor Dlabay Hughes. 16-1. What is a Mutual Fund?.

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C HAPTER 16

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  1. CHAPTER16 Investing in Mutual Funds Personal Finance 7e Kapoor Dlabay Hughes 16-1

  2. What is a Mutual Fund? • An investment chosen by people whose money is pooled with other investors to buy stocks, bonds, and other financial securities selected by professional managers who work for investment companies. • An investment company is a firm, that for a management fee, invests the pooled funds of small investors in securities appropriate to the fund’s stated objective. 16-2

  3. What is a Mutual Fund? (continued) • There are over 8,000 funds to choose from. • Many people choose mutual funds for their retirement account investments. • 401(k) or 403(b) • IRA • Roth IRA 16-3

  4. Why Investors Purchase Mutual Funds • Professional management. • Who is the fund’s manager? • Managers can change. • Diversification. • Investors funds are used to purchase a variety of investments. This variety provides some safety. 16-4

  5. Closed- and Open-End Funds • Closed-end funds (6% 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. • Open-end funds (93% of funds). • Shares are issued and redeemed by the investment company at the request of investors. • Investors are free to buy and sell shares at the net asset value (NAV). 16-5

  6. 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

  7. Net Asset Value (NAV) Value of the fund’s portfolio - Liabilities Number of shares outstanding Offer price = NAV + sales commission 16-7

  8. Load Funds and No-Load Funds • Load Fund. • Investors pay a commission (sales charge) up to 8.5% every time they purchase shares. This is sometimes called a front load. • Average charge is 3-5% for which an investor can get purchase advice and explanations. • No-Load Fund. • Investors pay no sales charge up front. • You deal directly with the investment company via 800 numbers or web sites, or from discount brokers. 16-8

  9. Management Fees and Other Charges • Management fee. • Charged yearly (.25%-1.25% average) based on a percentage of the funds asset value. • Contingent deferred sales load (back-end load). • Charged upon withdrawal of funds (1-5%). • Generally decreases on a sliding scale depending on the number of years shares are held. • 12b-1 fees. • Annual fee to defray advertising and marketing costs of the fund. • Approximately 1% of a fund’s assets per year. 16-9

  10. Number of Mutual Funds by Type* 16-10 *Source: Year 2000 data from the U.S. Bureau of the Census, Statistical Abstract of the United States, 2001, page 744.

  11. Classification of Mutual Funds • Stock funds. • Aggressive growth funds buy stocks in small, fast-growing companies. • Growth buy stock in companies with higher- than-average revenue and earnings growth. • Growth and income buy stock in growth companies, plus stock in companies with a predictable source of dividend income. • Equity income funds invest in stock of companies with a long history of paying dividends. • Index buys stocks that mirror an index. 16-11

  12. Classification of Mutual Funds (stock funds continued) • 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. • Regional funds buy stock in companies in a specific region of the world. 16-12

  13. Classification of Mutual Funds (stock funds continued) • Sector funds buy stock in companies in a particular sector such as biotechnology. • Large-cap funds buy stock in very large companies whose capitalization may be in the billions, while mid-cap funds buy stock in companies with a capitalization of 500 million or more. • Small cap funds buy stock in lesser-known companies with a capitalization of less than 500 million. 16-13

  14. Treasury Bond Treasury Note Classification of Mutual Funds (continued) • Bond funds. • Municipal bonds funds buy municipal bonds with tax-free interest income. • Insured municipal bonds provide tax-free income insured against default. • Long-term U.S. bonds with maturities of greater than 10 years. • Intermediate U.S. bond funds buy treasury notes with maturities of 5-10 years. • Short-term U.S. bond funds invest in U.S. Treasury issues of 1-5 years. 16-14

  15. Classification of Mutual Funds (continued) • Short-term corporate bonds with maturities of 1-5 years. • Intermediate corporate bonds (5-10 years). • Long-term corporate bonds (> 10 years). • High-yield (junk) bonds buy corporate bonds that are higher risk. • World bond funds buy bonds of foreign companies and governments. 16-15

  16. Classification of Mutual Funds (continued) • Other funds. • Balanced funds. • Invest in both stocks and bonds with the primary objective of conserving principal. • Money market funds. • Invest in CDs, government securities and other safe and liquid investments. • Asset allocation funds invest in various asset classes, with precise amounts within each type. 16-16

  17. 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 low or no charge. 16-17

  18. Steps to Evaluate Mutual Funds • Perform a financial checkup to make sure you are ready to invest. • Determine your risk tolerance. • Determine your investment objectives. • Obtain the money you need to purchase mutual funds. • Find a fund with an objective that matches your objective. • Evaluate, evaluate, and evaluate any mutual fund before buying or selling. 16-18

  19. Reading a Mutual Fund Quotein the Newspaper • 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. 16-19

  20. Other Sources of Fund Information • Mutual fund prospectus tells the funds objective, plus.. • 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

  21. Other Sources of Fund Information (continued) • Mutual fund annual report. • Performance, investments, assets and liabilities. • Financial Publications. • Business Week, Forbes, Kiplinger'sPersonalFinance and Money are sources of information. • Business Week’s mutual fund survey includes information such as the... • Fund’s overall rating compared to all other funds, and to funds in the same category. • Fund size, sales charge and expense ratio. • Historical returns for the past ten years. 16-21

  22. Internet Sources of Fund Information • Use web sites to research a fund. • www.finance.yahoo.com • www.businessweek.com • www.morningstar.net • www.smartmoney.com • Check mutual fund companies Internet sites. • www.troweprice.com • www.vanguard.com 16-22

  23. Who Owns Mutual Funds by Age* 16-23 *Source: Year 2000 data from the U.S. Bureau of the Census, Statistical Abstract of the United States, 2001, page 744.

  24. Mutual Fund Transactions • You can open an account from $250 to $3,000 and up depending on the fund family and the fund. • Open-end, no-load directly from the investment company by phone or through the mail, or from a discount broker. • Closed-end or exchange-traded funds are purchased via a broker through the stock exchange. 16-24

  25. Mutual Fund Transactions • There are several ways you can get a return on your investment. • You have capital gains when you sell shares at a higher price than you paid. • There may be income distributions when your fund sells securities. • Capital gain distributions are made. • Income and capital gain distributions can be automatically reinvested. • Keep accurate records for tax purposes, as gains and income are subject to taxation. 16-25

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