13 Investing in Mutual Funds

1. 13 Investing in Mutual Funds • Mutual Fund = an investment vehicle offered by investment companies to those who wish to: • Pool money • Buy stocks, bonds, and other financial securities • Have buy/sell decisions made by fund manager • Many mutual funds chosen for inclusion in retirement account investments (e.g., 401(k)s) 13-1

2. Objective 1Explain the Characteristics of Mutual Fund Investments Investment Company • Pools the money of many investors – its shareholders – to invest in a variety of securities • Employs fund manager who is compensated for selecting securities appropriate to the fund’s stated objective • “Financial Intermediary” 13-2

3. How a Mutual Fund Works

4. Why Investors Purchase Mutual Funds • Professional Management • Who is the fund’s manager? • How has the fund performed under the current managers? • Diversification • Investor’s funds are used to purchase a variety of investments (shares of many different companies) • Risk reduction 13-4

5. Characteristics of Funds • Closed-End Funds (7% of all Mutual Funds) • Fixed number of shares issued when the fund is organized • Trade like shares of common stock on stock exchanges • Trade price set by supply & demand • Actively managed • Most sell at a discount relative to their net asset value • Exchange-Traded Funds (6% of all Mutual Funds) • Invests to replicate the composition of a specific securities index • Performance mirrors index performance • Low management fees • Trade on exchanges throughout the day like stock • Prices determined by supply and demand • Can be sold short and traded with limit orders • Open-End Mutual Funds (87% of all Mutual Funds) • Shares issued and redeemed on demand • Actively managed 13-5

6. Net Asset Value Net Asset Value (NAV): Current market value of assets held by a fund AUM = “Assets Under Management” Net Assets = Fund Assets (AUM) - Liabilities NAV calculated at the close of trading Example:$52,500,000 value of fund net assets 3,500,000 number of shares = $15 per share 13-6

7. Open-End Funds Open-End Funds≈ Majority of funds • Shares issued and redeemed by investment company at the request of investors • Investors free to buy and sell shares at the net asset value (NAV) • No broker or stock exchange required • Wide variety of services • Automatic deposit and withdrawal • Exchanges among family of funds 13-7

8. Costs: Load Funds vs. No-Load Funds • Load Fund • Sometimes called an “A” fund • Commission (sales charge) up to 8.5% • Average = 3 to 5% • Paid every time shares purchased • Purchased through brokerage firms or registered representatives • Salespeople prepared to explain the fund and help determine if it meets the investor’s financial goals • No-Load Fund • No up-front sales charge • No salespeople • Investor deals directly with the investment company via 800 numbers or Web sites, or from discount brokers 13-8

9. Costs: Load Funds vs. No-Load Funds Contingent Deferred Sales Charge (CDSC) • “Back-end load” • “B” fund • “Redemption fee” • Charged upon withdrawal of funds (1-5%) • Generally decreases on a sliding scale depending on number of years shares are held • Disappears after about 5 years • Knowing your holding period is key factor 13-9

10. Costs: Management Fees and Other Charges • Management Fee • Charged yearly (.25%-1.5% of NAV average) based on a percentage of AUM • 12b-1 Fee • Annual fee to defray advertising and marketing costs • Cannot exceed 1% of AUM per year • Expense Ratio • Total expenses associated with management fees and operating costs of thefund 13-10

11. Typical Mutual Fund Fees 13-11

12. Objective 2Classify Mutual Funds by Investment Objective 13-12

13. Stock Funds 13-13

14. Bond Funds 13-14

15. Other Funds 13-15

16. Balancing Risk and Returns on Mutual Funds

17. A Family of Funds One investment company manages a group of mutual funds portfolios • Each fund has a different financial objective • Exchange privileges allow movement from one fund to another within the family with low or no charge • Listed alphabetically in newspapers Names of popular investment companies? 13-17

18. Objective 3Evaluate Mutual Funds Managed Funds vs. Index Funds • Managed Fund fund manager makes all decisions regarding what securities are included in the fund’s portfolio • Index Fund securities held by the fund replicate those contained in a specific index like the S&P 500 13-18

19. Sources of Fund Information • Internet sites provide current values • http://finance.yahoo.com • www.businessweek.com • www.morningstar.com • www.smartmoney.com • Check mutual fund companies’ Internet sites • www.troweprice.com • www.vanguard.com • Professional Advisory Services • Lipper Analytical Services • Morningstar, Inc. • Value Line • Mutual fund newsletters 13-19

20. Mutual Funds Have Different Investment Objectives Prospectus – a mutual fund’s investment objectives and policies must be stated in this document. • Two Types: • Traditional prospectus (long) • Profile prospectus (short)

21. Mutual Fund Prospectus Data • Fund objective(s) • Statement describing risk factors • Description of fund’s past performance • Statement describing type of investments in fund’s portfolio • Information about dividends, distributions, and taxes • Information about fund’s management • Procedure to buy and sell shares • Services provided to investors • Turnover Ratio of the fund’s investments: how often the fund’s portfolio changes 13-21

22. Other Sources of Fund Information • Mutual Fund Annual Report • Performance, investments, assets & liabilities • Financial Publications • Business Week, Forbes, Kiplinger'sPersonalFinance, WSJ, and Money • Business Week’s mutual fund survey includes: • 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 13-22

23. Objective 4Describe How and Why Mutual Funds are Bought and Sold The Mechanics of a Mutual Fund Transaction • Open an account: • On Your Own: $250 to $3,000 and up depending on the fund family and the fund • At Work: Select mutual funds for a tax-deferred retirement savings account 13-23

24. Return on Investment 3 Ways to Make Money on Mutual Funds Income Dividends • Earnings paid from dividend and interest income • Taxed as ordinary income Capital Gains Distributions • Distributions when the fund buys and sells securities • Taxed as long-term gains Capital Gains (or Losses) • Capital gains (or losses) when you sell shares at a price different than price you originally paid • Taxed as short- or long-term gains 13-24

25. Purchasing Open-End Fund Shares • Regular Account Transactions • Easiest • Simply buy shares in amount and when desired • Voluntary Savings Plans • Allows for smaller than usual purchases on a recurring basis • Contractual Savings Plans • Require regular purchases over a specified period • Reinvestment Plans • Automatically reinvests dividends and capital gains in the fund 13-25

26. The Wisdom of Automatic Reinvestment

27. Withdrawal Options • Closed-End Funds and Exchange-Traded Funds • Traded on stock exchanges and in over the counter market • Sold like common stock shares • Open-End Funds • Shares sold to the fund sponsoring company • Systematic withdrawal methods • Withdraw fixed dollar amount each period until account is exhausted • Liquidate or “sell off” a certain number of shares each period • Withdraw a fixed percentage of asset growth; principal untouched • Withdraw all income dividends and capital gains distributions; principal untouched 13-27

28. Wrap Up • Chapter Quiz • Concept Check 13-1- NAV Problem • Concept Check 13-2- Importance of Fund Objective • Concept Check 13-3- Managed Fund vs. Indexed Fund • Concept Check 13-4- Purchasing Closed-End Funds and ETFs