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Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
Chapter 12
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Chapter 12

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  • 1. Personal Finance: An Integrated Planning Approach Winger & Frasca Chapter 12 Mutual Funds and Other Pooling Arrangements http://www.prenhall.com/winger/
  • 2. Major Topics <ul><li>Mutual Funds </li></ul><ul><li>Investment Trusts </li></ul><ul><li>Limited Partnerships and Investment Clubs </li></ul><ul><li>Constructing and Maintaining Your Personal Portfolio </li></ul>
  • 3. Types of Pooling Arrangements <ul><li>Mutual Funds </li></ul><ul><ul><li>Closed End </li></ul></ul><ul><ul><li>Open End </li></ul></ul><ul><li>Investment Trusts </li></ul><ul><ul><li>Unit Investment Trusts (UITs) </li></ul></ul><ul><ul><li>Real Estate Investment Trusts (REITs) </li></ul></ul><ul><li>Limited Partnerships </li></ul><ul><li>Investment Clubs </li></ul>
  • 4. What Is A Mutual Fund? <ul><li>Pools the Funds of Many Individuals to Invest in Stocks, Bonds, and Many Other Types of Assets </li></ul><ul><li>A Fund’s Net Asset Value (NAV) is the Total Value of All the Assets the Fund Owns (minus any liabilities) Divided by the Number of Shares Issued by the Fund </li></ul>
  • 5. Fund X’s NAV <ul><li>Company # of Shares Price per Total </li></ul><ul><li>Owned Share Value </li></ul><ul><li>IBM 100 $120 $12,000 </li></ul><ul><li>Xerox 100 80 8,000 </li></ul><ul><li>GM 100 70 7,000 </li></ul><ul><li>Value of the fund’s portfolio $27,000 </li></ul><ul><li>Number of shares issued 1,000 </li></ul><ul><li>Fund X’s NAV $ 27.00 </li></ul>
  • 6. Load Versus No-Load Funds <ul><li>A Load is a commission paid to buy or sell fund shares </li></ul><ul><ul><li>Loads range from 1% to over 9% of NAV </li></ul></ul><ul><ul><li>No-load funds have no commission to buy shares (called a “front-end” load), but some charge a commission to sell (called a “back-end” load) </li></ul></ul><ul><li>There is no evidence showing that load funds do better than no-load funds </li></ul>
  • 7. Open-End Funds <ul><li>Most Popular Type of Fund </li></ul><ul><ul><li>They Advertise Extensively to Attract Investors </li></ul></ul><ul><ul><li>Large Funds Include Fidelity, Vanguard </li></ul></ul><ul><li>You Can Deal Directly with the Fund to Buy or Sell Shares </li></ul><ul><ul><li>Completing an Application Form is Easy </li></ul></ul><ul><ul><li>Shares Are Purchased/Sold at NAV (Plus a Load, if Applicable) </li></ul></ul><ul><ul><li>You Can Use Many Fund Services </li></ul></ul>
  • 8. Closed-End Funds <ul><li>Shares Trade in the Securities Markets </li></ul><ul><ul><li>You Trade Shares As You Would the Shares of Any Company, such as Intel </li></ul></ul><ul><ul><li>While You Do Pay a Broker’s Commission, There Are No Loads </li></ul></ul><ul><li>Shares Trade at Premiums or Discounts to NAV </li></ul><ul><ul><li>Discounts Can Be Attractive; In Effect, You Buy $1.00 Worth of Securities for Less than $1.00 </li></ul></ul>
  • 9. Fund Objectives <ul><li>Type of Fund Objective </li></ul><ul><li>___________ _______________________________ </li></ul><ul><li>Growth Price Appreciation over Time </li></ul><ul><li>Income High Current Return </li></ul><ul><li>Balanced Good Current Return with some Growth </li></ul><ul><li>Money Mkt. High Liquidity and Returns Better than </li></ul><ul><li>Bank Returns </li></ul><ul><li>Maximum Exploit Opportunities to Earn Very High </li></ul><ul><li>Appreciation Returns </li></ul>
  • 10. Fund Objectives,Continued <ul><li>Type of Fund Fund Objective </li></ul><ul><li>____________ _______________________________ </li></ul><ul><li>Sector Invests in Only One Industry </li></ul><ul><li>International Earn Returns in Countries outside the </li></ul><ul><li>United States </li></ul><ul><li>Global Earn Returns in both the United </li></ul><ul><li>States and Foreign Countries </li></ul><ul><li>Index Earn Returns Equal to a Market Index </li></ul><ul><li>Returns </li></ul>
  • 11. Mutual Fund Services <ul><li>Reinvestment Plans </li></ul><ul><ul><li>Can Reinvest Dividends and Capital Gains </li></ul></ul><ul><li>Transactions by Telephone and Internet </li></ul><ul><li>Fund Switching within a Fund Family </li></ul><ul><ul><li>Can Sell Shares of One Fund and Reinvest in Shares of Another Fund </li></ul></ul><ul><ul><li>Be Careful of Loads </li></ul></ul><ul><li>Adaptability to IRAs </li></ul>
  • 12. Selecting a Mutual Fund <ul><li>Evaluate Performance </li></ul><ul><li>Review the Fund’s Current Portfolio </li></ul><ul><li>Examine Expenses and Turnover </li></ul><ul><li>Review Evaluations in Popular Magazines and Newspapers </li></ul><ul><li>Consult a Professional Evaluation Service, such as Morningstar </li></ul>
  • 13. Performance Measurements <ul><li>Growth of $1,000 over Time </li></ul><ul><ul><li>Example: a cumulative total return of 259.45% means that $1,000 invested 10 years ago has earned $2,594.50 and the investment is now worth $3,594.50 </li></ul></ul><ul><ul><li>Assumes that All Dividends Are Reinvested as They Are Earned Each Quarter </li></ul></ul><ul><li>Average Annual Total Return (AATR) </li></ul><ul><ul><li>Expresses the Cumulative Return as a Yearly Average: 13.65% for the Above </li></ul></ul>
  • 14. The Risk-Adjusted Rate of Return (RAROR) <ul><ul><li>Adjusts a Funds AATR by Its Beta Value and Compares this Adjusted Return to the Overall Market Return </li></ul></ul><ul><li>RAROR = (AATR/Beta) - S&P 500 Return </li></ul><ul><ul><li>Example: AATR = 13.65%, Beta = 0.86, S&P 500 Return = 14.39% </li></ul></ul><ul><ul><li>RAROR = (13.65%/0.86) - 14.39% </li></ul></ul><ul><ul><li>= 15.87% - 14.39% </li></ul></ul><ul><ul><li>= + 1.48% </li></ul></ul>
  • 15. Interpreting RARORs <ul><li>A Positive RAROR Indicates Good Fund Management </li></ul><ul><li>A Negative RAROR Indicates Poor Fund Management </li></ul><ul><li>It is Important to Have + RARORS Consistently Over Time--Do Not Rely Too Heavily on One Year’s Number </li></ul>
  • 16. Other Evaluation Items <ul><li>Review the Fund’s Current Portfolio </li></ul><ul><ul><li>Is There Adequate Diversification? </li></ul></ul><ul><li>Review the Fund’s Operating Expenses </li></ul><ul><ul><li>Usually Expressed as a % of Net Assets </li></ul></ul><ul><ul><li>Small %s Are Desirable </li></ul></ul><ul><li>Examine the Portfolio Turnover % </li></ul><ul><ul><li>Turnover % Measures the Trading Frequency: High Numbers = Much Trading </li></ul></ul>
  • 17. Fund Evaluations <ul><li>The Popular Press </li></ul><ul><ul><li>Wall Street Journal--Each Friday Issue </li></ul></ul><ul><ul><li>Money Magazine </li></ul></ul><ul><ul><li>Business Week </li></ul></ul><ul><ul><li>Forbes </li></ul></ul><ul><li>Professional Evaluations </li></ul><ul><ul><li>Morningstar is An Example </li></ul></ul><ul><ul><li>You Pay for this Service BUT Check Out Morningstar’s Web Site for Free Info </li></ul></ul>
  • 18. Unit Investment Trust <ul><li>Similar to an Open-End Fund </li></ul><ul><ul><li>Trust Units (Shares) Are Purchased from and Redeemed by the Fund Originator </li></ul></ul><ul><ul><li>Redemption is at Current Market Value </li></ul></ul><ul><li>Major Difference </li></ul><ul><ul><li>A Trust’s Portfolio is Unmanaged; i.e., Once Established It Is Left Virtually Unchanged </li></ul></ul><ul><ul><li>This Leads to Very Low Operating Costs </li></ul></ul><ul><ul><li>However, UITs Have Loads </li></ul></ul>
  • 19. Creation of a UIT Trust Originator Buys a Portfolio of Bonds and Sells Trust Units to Individual Investors Investor A Investor B Investor C Who May Hold Their Units to Maturity or May Sell Back to Originator--at Current Market Value
  • 20. Exchange Traded Funds <ul><li>UITs that trade in the securities markets, similar to closed-end funds </li></ul><ul><li>Relatively fixed portfolios </li></ul><ul><ul><li>Based on broad market (QQQs, Spiders, Diamonds, others) </li></ul></ul><ul><ul><li>Based on market segments (Industry ETFs, Holders, others) </li></ul></ul>
  • 21. ETF Advantages (Disadvantage) <ul><li>Positions can be taken quickly, just as with any individual stock </li></ul><ul><li>Shares can be purchased on margin </li></ul><ul><li>Very low expense ratios </li></ul><ul><li>Tax advantage insofar as investors can avoid capital gains by simply not selling </li></ul><ul><li>But, commissions must be paid on trades </li></ul>
  • 22. Real Estate Investment Trusts <ul><li>Similar to a Closed-End Fund </li></ul><ul><ul><li>Equity per Share (EqPS) of a REIT is Similar to NAV and Calculated as Follows: </li></ul></ul><ul><ul><li>(Assets - Liabilities)/REIT Shares Outstanding </li></ul></ul><ul><li>Types of REITs </li></ul><ul><ul><li>Equity Trust: Invest in Rental Properties </li></ul></ul><ul><ul><li>Mortgage Trust: Invests in Mortgages </li></ul></ul><ul><li>Investment Appeal: Easy Way to Include Real Estate in a Portfolio </li></ul>
  • 23. Limited Partnerships (LPs) <ul><li>Formed by: </li></ul><ul><ul><li>General Partner Who Runs the Business </li></ul></ul><ul><ul><li>Limited Partners Who Put Up the Money </li></ul></ul><ul><li>Invest in a Various Activities, Such As: </li></ul><ul><ul><li>Real Estate </li></ul></ul><ul><ul><li>Energy Programs </li></ul></ul><ul><ul><li>Equipment Leasing </li></ul></ul>
  • 24. Limited Partnerships (LPs) <ul><li>Unique Feature is the Pass Through of Business Profits and Losses to the Limited Partners </li></ul><ul><li>Losses Can Have Significant Advantages if Used to Offset Other Taxable Income </li></ul><ul><li>However, Current Tax Code Severely Limits Such Deductions </li></ul><ul><li>Making LPs an Undesirable Vehicle for Most Investors </li></ul><ul><li>Moreover, LP Interests Cannot be Sold Easily, Making Your Investment Highly Illiquid </li></ul>
  • 25. Investment Clubs <ul><li>Characteristics </li></ul><ul><ul><li>Frequent Meetings, Usually Monthly </li></ul></ul><ul><ul><li>Low Monthly Contributions, $25 - $50 </li></ul></ul><ul><ul><li>Members Do Research on Specific Stocks </li></ul></ul><ul><li>Advantages </li></ul><ul><ul><li>Diversification </li></ul></ul><ul><ul><li>Help with Investing Workload </li></ul></ul><ul><ul><li>Fun and Fellowship </li></ul></ul>
  • 26. Investment Clubs <ul><li>Disadvantage: </li></ul><ul><ul><li>Too Much Fun, Not Enough Research </li></ul></ul>
  • 27. Portfolio Construction: Aggressive Investor <ul><li>Characteristics </li></ul><ul><ul><li>Risk Tolerance: High </li></ul></ul><ul><ul><li>Return Preference: Future Return </li></ul></ul><ul><ul><li>Priority of Specific Future Goals: Not Strong </li></ul></ul><ul><li>Investor Types </li></ul><ul><ul><li>Persons with No Dependents </li></ul></ul><ul><ul><li>Wealthy Investors </li></ul></ul>
  • 28. Portfolio Construction: Cautious Investor <ul><li>Characteristics </li></ul><ul><ul><li>Risk Tolerance: Low </li></ul></ul><ul><ul><li>Return Preference: Future Return </li></ul></ul><ul><ul><li>Priority of Specific Future Goals: Very Strong </li></ul></ul><ul><li>Investor Types </li></ul><ul><ul><li>Anyone with Dependents </li></ul></ul><ul><ul><li>Investors Planning Retirement </li></ul></ul><ul><ul><li>Investors Planning a Major Purchase </li></ul></ul>
  • 29. Portfolio Construction: Investor Who Needs Income <ul><li>Characteristics </li></ul><ul><ul><li>Risk Tolerance: Moderate </li></ul></ul><ul><ul><li>Return Preference: Current Return </li></ul></ul><ul><ul><li>Priority of Specific Future Goals: Moderately Strong </li></ul></ul><ul><li>Investor Types </li></ul><ul><ul><li>Retirees </li></ul></ul><ul><ul><li>Persons with Dependents to Support </li></ul></ul><ul><ul><li>Persons with No Major Future Expenses </li></ul></ul>
  • 30. Investment Selection <ul><li>Aggressive Investor </li></ul><ul><ul><li>100% Stocks: 1/3 Large Company, 1/3 Small Company, 1/3 International </li></ul></ul><ul><li>Cautious Investor </li></ul><ul><ul><li>30% Large Company Growth Stocks, the Balance in Bonds, including Zero-Coupon </li></ul></ul><ul><li>Investor Who Needs Income </li></ul><ul><ul><li>50% High-Quality Corporate Bonds, 25% Medium-Quality Corporate Bonds, and 25% Income Stocks </li></ul></ul>
  • 31. Maintaining a Portfolio <ul><li>Stocks Bonds </li></ul><ul><li>(1) Amount Invested </li></ul><ul><li>Initially $10,000 $10,000 </li></ul><ul><li>(2) Current Market </li></ul><ul><li>Values 15,000 9,000 </li></ul><ul><li>(3) Adjustment with </li></ul><ul><li>Constant Ratio Plan * - 3,000 + 3,000 </li></ul><ul><li>(4) Adjusted Balances 12,000 12,000 </li></ul><ul><li>____________ </li></ul><ul><li>* A Variable Ratio Plan Would Sell More Stocks and Buy More Bonds </li></ul>
  • 32. 401(k) Plan Considerations <ul><li>Don’t Reject Participation </li></ul><ul><li>Diversify Broadly Using a Variety of Funds </li></ul><ul><li>Coordinate Out-of-Plan Investments with In-Plan Investments </li></ul><ul><li>Don’t Try to Time the Markets, Even Though Gains Are Not Taxed </li></ul><ul><li>Avoid Excessive Conservatism </li></ul>
  • 33. Next Chapter 13 Property and Liability Insurance

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