Chapter 13 Investing In Mutual Funds
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  • 1. Chapter 13 Investing In Mutual Funds 13-1 Kapoor Dlabay Hughes Ahmad Prepared by Cyndi Hornby, Fanshawe College  2009 McGraw-Hill Ryerson Ltd.
  • 2. Learning Objectives - Chapter 13
    • Describe the characteristics of mutual funds.
    • Classify mutual funds by investment choice.
    • Evaluate mutual funds for investment purposes.
    • Describe how and why mutual funds are bought and sold.
    13-2
  • 3. Learning Objective # 1 Describe the characteristics of mutual funds. 13-3
  • 4. What is a Mutual Fund?
    • An investment chosen by people who pool their money to buy stocks, bonds, and other financial securities selected by professional managers who work for investment companies.
    • Each investor has a right to a proportional share of the assets of the fund and any income it earns
    • Many people choose mutual
    • funds for their retirement
    • account.
    13-4
  • 5. Why Investors Purchase Mutual Funds
    • Professional management
      • Who is the fund’s manager?
      • Managers can change so investors must be careful
    • Diversification
      • Investors funds are pooled and used to purchase a variety of investments.
      • Funds own stock in hundreds of different companies
      • Buys from different asset classes (stocks, bonds & other securities
    • Investment Company
      • A firm that, for a management fee, invests the pooled finds of small investors in securities appropriate to its stated investment objectives
    13-5
  • 6. Characteristics of Mutual Funds
    • Closed-end funds
      • A fund of finite size
      • Shares are issued by an investment company only when the fund is originally set up
      • After all original shares are sold you can only purchase shares from another investor
    • Open-end 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.
    13-6
  • 7. Characteristics of Mutual Funds
    • Net Asset Value
      • The current market value of the securities contained in the mutual funds portfolio minus the mutual funds liabilities divided by the number of shares outstanding
      • Calculated at the close of trading each day
    • (Value of the fund’s portfolio – Liabilities)
    • Number of shares outstanding
    13-7
  • 8. Characteristics of Mutual Funds
    • Index Fund
      • An affordable way for investors to invest in a diversified basket of securities; constructed to track the components of a market index such as the S&P 500 or the S&P/TSX Composite
    • Exchange Traded Funds (ETF’s)
      • An affordable way for investors to invest in a diversified basket of securities; provides the diversification of an index fund with the flexibility of a stock
    • Short Sell
      • The practice of selling a borrowed stock in the hope of covering the sale by buying it at a lower price later
    13-8
  • 9. Characteristics of Mutual Funds
    • Load Fund
      • A mutual fund in which investors pay a commission (as high as 8.5%) every time they purchase or sell shares
    • No-Load fund
      • No sales charge
    • Front-end load
      • A sales fee charged with each purchase; reduces the funds actually invested. Most fund companies have lowered the maximum front-end load on their funds to around 6 %
    • Back-end load
      • Also referred to as a contingent deferred sales load. One to six percent of withdrawals on sliding scale decreasing with time held, then zero if selling after a set number of years.
    13-9
  • 10. Management Fees & Other Charges
    • Expense Ratio
      • Expressed as a fixed percentage of the fund’s total value, called the Management Expense Ratio (MER). Ranges from 0.25 percent (rare) to 4 percent, to cover investment company’s costs. Fee is up to 0.5 percent higher for back-end load funds.
    • Special Fees
      • Annual RRSP, RRIF, RESP trustee fee
      • Account set up fee
      • Short term trading fee
      • Processing fee
      • Service fees
    13-10
  • 11. Learning Objective # 2 Classify mutual funds by investment choice. 13-11
  • 12. Classification of Mutual Funds
    • Money Market Funds
      • Income and liquidity through investment in short-term money market instruments
      • T-bills, commercial paper, short-term government bonds
    • Mortgage funds
      • Aim for income and safety
      • Hold a group of mortgages
    • Bond Funds
      • Aim for safety of principal and income but are subject to capital gains and losses, which have tax implications.
      • Government and corporate debt securities.
    13-12
  • 13. Classification of Mutual Funds
    • Dividend Funds
      • Aim for tax-advantage income
      • Possibility of capital growth
      • Invest in preferred shares
      • High quality common shares
    • Balanced and Asset Allocation funds
      • Provide a mixture of safety, income and capital appreciation.
    • Equity or Common Stock funds
      • Capital gains
      • Common shares
    13-13
  • 14. Classification of Mutual Funds
    • Specialty funds
      • Sacrifice diversification in an effort to build capital gains.
      • One industry, geographical area
      • Segment of the capital market
    • International or Global funds
      • Subset of specialty funds
    • Real Estate funds
      • Long-term growth through capital appreciation
      • Income-producing real property
    13-14
  • 15. Classification of Mutual Funds
    • Ethical funds
      • Investment decisions that are guided by moral criteria
    • Segregated funds
      • Insurance companies as an alternative
      • Guarantee that a portion of your principal will be returned to you at maturity
    • Labour-sponsored venture capital corporations (LSVCCs)
      • Sponsored by labour organizations
      • Invest in small to medium-sized businesses
    13-15
  • 16. Fund Families
    • A family of funds exists when one investment company manages a group of mutual funds.
    • Funds in the family vary in their objectives.
    • You can move your money from one fund to another within a fund family with low or no charge.
    • Market Timer: an individual who helps investors decide when to switch their investments from one fund to another, usually within the same family
    13-16
  • 17. Learning Objective # 3 Evaluate mutual funds for investment purposes. 13-17
  • 18. Steps to Evaluate Mutual Funds
    • Perform a financial checkup to make sure you are ready to invest.
    • Obtain the money needed to purchase mutual funds.
    • Determine your investment objectives.
    • Find a fund with an objective that matches your objective.
    • Evaluate, evaluate, and evaluate any mutual fund before buying or selling.
    13-18
  • 19. Reading a Mutual Fund Quote in the Newspaper
    • Net asset value and asset value change.
    • Company and fund name.
    • Fund objective.
    • Total return over various time periods.
    • Ranking among funds with the same objective.
    • Sales load or no load (NL).
    • Percent of annual average net expenses.
    13-19
  • 20. Other Sources of Fund Information
    • Mutual fund prospectus.
      • 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 about dividends, distributions and taxes.
      • Information about the fund’s management.
      • Limitations when choosing investments
    13-20
  • 21. Other Sources of Fund Information
      • Process to buy and sell shares
      • Service provided and cost
      • How often investment portfolio changes
      • Provides a wealth of information to help you make an investment choice
      • Summarizes fund’s objectives
      • Provides a summary of the fess charged
    13-21
  • 22. Other Sources of Fund Information
    • Mutual Fund Annual Report
      • Performance, investments, assets and liabilities
    • Mutual Fund Guidebooks
    • Financial Publications
      • IE: Money
      • Canadian Business
      • Report on Business
    • The Internet
      • Internet search engines
      • Investment company web pages
    13-22
  • 23. Learning Objective # 4 Describe how and why mutual funds are bought and sold. 13-23
  • 24. Advantages of Mutual Funds
    • Diversification
    • Professional Management
    • Ease of buying and selling
    • Small amount of money required to open an account
    • Multiple withdrawal options
    • Distribution or reinvestment of income and capital gains
    • Switching privileges in fund family
    • Multiple services
    13-24
  • 25. Disadvantages of Mutual Funds
    • Purchase and withdrawal costs
    • Ongoing management fees
    • Potential poor performance
    • No control over capital gains distribution
    • Complicated tax reporting issues
    • Potential market risk with all investments
    • Some sales personnel are aggressive
    13-25
  • 26. Mutual Fund Transactions
    • Return on investment
    • Income dividends
      • The earnings a fund pays to shareholders after it has deducted expenses from its dividend and interest income
    • Capital gain distributions
      • The payments made to a fund’s shareholders that result from the sale of securities in the fund’s portfolio
    • Sell shares at a higher price than you paid
    13-26
  • 27. Mutual Fund Transactions
    • Taxes and Mutual Funds
      • Most returns subject to taxation
      • Companies required to send statement specifying how much received in dividends and capital gains distribution
      • Although you do not receive cash (as the returns are reinvested) they are still taxable
      • Can be taxed in year when your burden is already heavy
      • May be taxed for full year even if you own for only part of the year
    13-27
  • 28. Mutual Fund Transactions
    • Purchase options
      • Closed-end through the stock exchange
      • Open-end, no-load directly from the investment company by phone or through the mail, or a sales representative
    • Reinvestment Plan
      • Dividends and capital gains reinvested to buy additional shares
    13-28
  • 29. Mutual Fund Transactions
    • Withdrawal Options
      • Closed-end funds sold to another investor
      • Open-end funds sold to the investment company that sponsors the fund
        • shares redeemed at their Net Asset Value
      • Withdraw specified, fix dollar amount until fund exhausted
      • Sell certain number of shares over period
      • Withdraw fixed percentage of asset growth
      • Withdraw all asset growth, leave principal untouched
    13-28
  • 30. Summary of Learning Objectives
    • Describe the characteristics of mutual fund investments
      • Major reasons chosen are professional management and diversification
      • Closed end fund is one whose shares are only issued when fund set up
      • Open end fund shares are sold and redeemed by the investment company at the net asset value (NAV) at the request of the investors
    13-30
  • 31. Summary of Learning Objectives
    • Describe the characteristics of mutual fund investments
      • A load fund charges commission every time your purchase shares
      • No commission is charged to purchase a no-load fund
      • Can also be front-end or back-end load
      • Other possible fees include management fees and contingent deferred sales loads
    13-31
  • 32. Summary of Learning Objectives
    • Classify mutual funds by investment objectives
      • Tailored to meet the investment objectives of their customers
        • Money market funds
        • Mortgage funds
        • Bond funds
        • Dividend funds
        • Balanced and Asset Allocation funds
        • Equity or Common Stock funds
        • Specialty funds
    13-32
  • 33. Summary of Learning Objectives
    • Classify mutual funds by investment objectives
      • Tailored to meet the investment objectives of their customers
        • International or Global funds
        • Real Estate funds
        • Ethical funds
        • Segregated funds
        • Labour-sponsored venture capital corporations
      • Many companies use fund family concept to allow investors to switch among funds for more potential, financial reward and security
    13-33
  • 34. Summary of Learning Objectives
    • Evaluate mutual funds for investment purposes
      • Responsibility for choosing the right fund rests with the investor
      • Information found in newspapers, financial objectives of fund, information in prospectus and annual reports, financial publications, professional advisory services, and the Internet
    13-34
  • 35. Summary of Learning Objectives
    • Describe how and why mutual funds are bought and sold
      • The advantages and disadvantages have made mutual funds the investment of choice for many
      • Share of closed end funds are sold on organized stock exchanges
      • Share of open end funds can be purchased from authorized salesperson, brokerage firm, mutual fund supermarket or investment company
    13-35
  • 36. Summary of Learning Objectives
    • Describe how and why mutual funds are bought and sold
      • Shareholders in mutual funds can receive return in one of three ways;
        • Income dividends
        • Capital gain distributions
        • Capital gains when sold at a higher price than originally paid
      • A number of purchase and withdrawal options are available
    13-36