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Investing in Mutual Funds

Investing in Mutual Funds. Dr. Steven M. Hays BKHS Personal Finance. What is a Mutual Fund?. An investment alternative where money from investors is pooled to buy stocks, bonds, and other financial securities selected by professional managers.

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Investing in Mutual Funds

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  1. Investing in Mutual Funds Dr. Steven M. Hays BKHS Personal Finance

  2. What is a Mutual Fund? • An investment alternative where money from investors is pooled to buy stocks, bonds, and other financial securities selected by professional managers. • Many people choose mutual funds for their retirement account investments. • 401(k) or 403(b) • IRA • Roth IRA 16-2

  3. Mutual Fund Statistics • 92 million individuals in 54 million households in the U.S. own mutual funds. • Over 8,000 mutual funds by 2004. • Over $8 trillion in assets owned by mutual funds in the U.S. by 2004. 16-3

  4. 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

  5. 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

  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 For most mutual funds, NAV is calculated at the close of trading each day. 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. (Class A shares) • 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 fund with 800 numbers or web sites, or from discount brokers. 16-8

  9. 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

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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. 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

  17. 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

  18. Internet Sources of Fund Information • Use web sites to research a fund. • http://finance.yahoo.com • www.businessweek.com • www.morningstar.com (also other advisory services, such as Value Line). • www.smartmoney.com • Check mutual fund companies Internet sites. • www.trendstarfunds.com • www.vanguard.com 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 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

  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. • Performance for best and worst quarters. 16-21

  22. 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

  23. Mutual Fund Transactions • There are several ways you can get a return on your investment. • Capital gains: sell shares at a price > than you paid (Report on Schedule D and 1040). • Income dividends: earnings funds pay to shareholders from dividend and interest income (Taxed as regular income). • Capital gain distributions: Payments to shareholders from sale of securities held by the fund (Show on Schedule D and 1040). • Income and capital gain distributions can be automatically reinvested. 16-23

  24. Mutual Fund Features • Automatic investments: Money is taken from your checking account monthly and invested in a fund. • Telephone Switching: Call your fund and move money from one fund to another in the same family. • Withdrawals: Various withdrawal options; you can withdraw funds by phone, letter, online, etc. 16-24

  25. Mutual Fund Homework Activity • Go online to www.morningstar.com, www.cbsmarketwatch.com or other sources and do some research on mutual funds. • Find a fund that you feel would be a good investment for you. • Write a one-page summary of the fund and how that fund would meet your investment objectives. 16-25

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