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Chapter 16

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  • 1. Chapter 16 Investing in Mutual Funds McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
  • 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* 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.
      • 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
      • 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 (continued)
  • 13. Classification of Mutual Funds
    • 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).
    (continued) 16-13
  • 14. Classification of Mutual Funds
      • 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.
    (continued) 16-14
  • 15. Classification of Mutual Funds
    • 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.
    (continued) 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 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.
    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
    • 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.
        • Performance for best and worst quarters.
    16-21 (continued)
  • 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 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.
    • Pair off with another student. Compare your mutual fund selections and discuss your investment objectives and how this fund will meet those objectives.
    16-25

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