Net Asset Value (NAV) Classification of Mutual Funds. Load Funds and No-Load Funds. Classification of Mutual Funds

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1 CHAPTER 16 Why Investors Purchase Mutual Funds Investing in Mutual Funds Personal Finance 7e Kapoor Dlabay Hughes 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 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 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) What is a Mutual Fund? 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 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

2 Net Asset Value (NAV) Number of Mutual Funds by Type* Value of the fund s portfolio - Liabilities Number of shares outstanding Offer price = NAV + sales commission 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Equity Funds Bond Funds Hybrid Funds Money Money Market, Market, Tax Taxable Exempt 16-7 *Source: Year 2000 data from the U.S. Bureau of the Census, Statistical Abstract of the United States, 2001, page 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 Stock funds. Aggressive growth funds buy stocks in small, fast-growing companies. Growth buy stock in companies with higher- thanaverage 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. 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 (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

3 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. (stock 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 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. Treasury Bond Treasury Note 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 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 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

4 Reading a Mutual Fund Quote in 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 Internet Sources of Fund Information Use web sites to research a fund. Check mutual fund companies Internet sites 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 Who Owns Mutual Funds by Age* 27% 25% 2% 18% 28% *Source: Year 2000 data from the U.S. Bureau of the Census, Statistical Abstract of the United States, 2001, page 744. Less than age years old years old years old Over 55 years old Other Sources of Fund Information Mutual fund annual report. Performance, investments, assets and liabilities. Financial Publications. Business Week, Forbes, Kiplinger's Personal Finance 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 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

5 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

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