Chapter 15: Investing Through Mutual Funds


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  • Item one: specify “identical” to what? (p436)
  • Chapter 15: Investing Through Mutual Funds

    1. 1. Chapter Fifteen Investing Through Mutual Funds
    2. 2. Learning Objectives <ul><li>Summarize two types of investment returns that investors expect from mutual funds. </li></ul><ul><li>Classify mutual funds by investment objectives. </li></ul><ul><li>Describe unique features of mutual funds that make them attractive. </li></ul><ul><li>Distinguish among load and no-load mutual funds </li></ul><ul><li>Explain how to avoid various charges and fees. </li></ul><ul><li>Explain how to evaluate mutual funds to invest in. </li></ul>
    3. 3. Introduction <ul><li>Investment Company – corporation, trust, or partnership in which investors with similar financial goals pool their money to... </li></ul><ul><li>utilize professional management </li></ul><ul><li>diversify their investments </li></ul>What are some large mutual fund investment companies?
    4. 4. Introduction (Continued) <ul><li>Mutual Fund – an investment company that </li></ul><ul><li>combines the funds of investors who have purchased shares of ownership </li></ul><ul><li>invests that money in a diversified portfolio of stocks and bonds issued by other corporations or governments. </li></ul><ul><li>Portfolio – consists of a collection of securities and other investment alternatives. </li></ul>
    5. 5. Types of Investment Companies <ul><li>Closed-End Investment Company – issues a limited and fixed number of shares and does not buy them back. </li></ul><ul><ul><li>Shares trade like stock on stock exchanges </li></ul></ul><ul><li>Open-End Mutual Fund – always ready to sell new shares of ownership and buy back previously sold shares at the fund’s current share price. </li></ul><ul><ul><li>More than 90% of all mutual funds </li></ul></ul>
    6. 6. Figure 15.1: How a Mutual Fund Works
    7. 7. Investors Expect Mutual Fund Dividend and Capital Gains Income <ul><li>Mutual Fund Dividends – income paid to investors out of profits earned by the mutual fund from the investments it has made. </li></ul><ul><ul><li>Mutual funds dividends represent current income to mutual fund shareholders. </li></ul></ul><ul><li>Capital Gains Distributions – represent net gains that a fund realizes when it sells securities held in the fund’s portfolio. </li></ul><ul><ul><li>Recommended strategy: reinvest dividends and capital gains into additional shares . </li></ul></ul>
    8. 8. Investors Expect Capital Gains Through Price Appreciation <ul><li>Mutual fund investors also expect to profit when they sell their shares. </li></ul><ul><li>Net Asset Value (NAV) – the per-share value of a mutual fund. </li></ul><ul><li>Example : $52,500,000 value of fund </li></ul><ul><li>3,500,000 number of shares = $15 per share </li></ul><ul><li>Unrealized Capital Gains – merely “paper profits” on securities in the mutual fund. </li></ul><ul><li>When such gains are “ realized ” by the fund, they are paid to investors as capital gains distributions. </li></ul>
    9. 9. Mutual Funds Have Different Investment Objectives <ul><li>Prospectus – a mutual fund’s investment objectives must be stated in this. </li></ul><ul><li>Two Types: </li></ul><ul><li>Traditional prospectus (long) </li></ul><ul><li>Profile prospectus (short) </li></ul>
    10. 10. Funds with an Income Objective <ul><li>Bond Fund – aims to earn current income without incurring undue risk and to pay ordinary income dividend distributions. </li></ul><ul><li>Municipal Bond (Tax-Exempt) Fund – attempts to earn current tax-exempt income by investing solely in municipal bonds issued by cities, states, and political subdivisions. </li></ul><ul><li>Mortgage Fund – invests in mortgage-backed securities (e.g., Ginnie Maes) </li></ul>
    11. 11. Funds with a Balanced Objective <ul><li>Balanced Funds – invest in a mixture of bonds, preferred stocks, and blue-chip common stocks. </li></ul><ul><li>Often 60% stocks, 40% bonds </li></ul><ul><li>Often have the word “balanced” in fund name </li></ul>
    12. 12. Funds with a Growth Objective <ul><li>Growth Fund – seeks long-term capital appreciation by investing in the common stocks of companies whose values are expected to grow faster than usual. </li></ul><ul><li>Value Fund – specializes in growth stocks whose prices appear to be low, based on the logic that such stocks are currently out of favor and under-priced. </li></ul>
    13. 13. Funds with a Growth Objective (Continued) <ul><li>Aggressive-Growth Fund (or Maximum Capital Gains Fund) – seeks greatest long-term capital appreciation and incurs greatest fluctuation in price. </li></ul><ul><li>Small-Cap Fund ( or Small-Capitalization Fund) – specializes in investing in smaller companies with market capitalization less than $1 billion. </li></ul><ul><li>Sector Fund – heavily invests in common stocks from one industry or one portion of the economy. </li></ul><ul><li>Precious Metals and Gold Funds – seek long-term capital appreciation by investing in securities associated with gold, silver, other precious metals. </li></ul>
    14. 14. Funds with a Growth Objective (Continued) <ul><li>Global Fund – invests primarily in growth stocks of companies listed on foreign and U.S. exchanges. </li></ul><ul><li>International Funds – hold only foreign stocks, and some such funds focus on a single country or geographic region. </li></ul>
    15. 15. Funds with a Growth and Income Objective <ul><li>Growth and Income Fund – objective is a combination of growth and income; invests in companies expected to show average or better growth and pay steady or rising dividends. </li></ul><ul><li>Life-Cycle Funds – create a diversified, all-in-one (stocks, bonds, and cash assets) portfolio for those individuals who do not wish to actively manage their investments. </li></ul>
    16. 16. Other Types of Funds <ul><li>Socially Conscious Funds – funds that aim to invest in firms with good records on the environment, human rights, and public safety. </li></ul><ul><ul><li>Screen for various negative factors (e.g., smoking, alcohol, polluters, gambling) </li></ul></ul><ul><li>“ Funds of Funds” – funds that earn a return by investing in other mutual funds, thereby providing extensive diversification. </li></ul>
    17. 17. Unique Features of Mutual Funds <ul><li>Easy Purchase and Sale – after opening an account, you can easily buy and sell shares </li></ul><ul><li>Easy Access - check Writing and wiring of funds </li></ul><ul><li>Automatic Investment – Most funds allow investors to make periodic (monthly or quarterly) payments using money automatically transferred from a bank account </li></ul><ul><li>Automatic Reinvestment – allows automatic use of dividend and capital gains distributions and interest to buy additional shares of the fund without paying any commissions. </li></ul>
    18. 18. Figure 15.2: The Wisdom of Automatic Reinvestment
    19. 19. Switching Privileges within a Mutual Fund Family <ul><li>Switching Privilege (or Exchange Privilege) – permits mutual fund shareholders to easily swap shares on a dollar-for-dollar basis for shares in another mutual fund within a mutual fund family. </li></ul><ul><li>Exchange Fee – a small charge, typically $5 or $10 per transaction, on transfers from one fund to another. </li></ul><ul><li>Mutual Fund Family – when the same management company operates a variety of mutual funds, each with its own investment objectives. </li></ul>
    20. 20. Withdrawal Plans <ul><li>Withdrawal Plans (or Systematic Withdrawal Plans) – available to shareholders who want a periodic income from their mutual fund investments. </li></ul><ul><li>You can take your funds out of a mutual fund using one of four methods: </li></ul><ul><ul><li>By taking a set dollar amount each month. </li></ul></ul><ul><ul><li>By cashing in a set number of shares each month. </li></ul></ul><ul><ul><li>By taking the current income as cash. </li></ul></ul><ul><ul><li>By taking a portion of the asset growth. </li></ul></ul>
    21. 21. Mutual Fund Expenses <ul><li>Management Fee – annual assessment to pay advisors who operate the mutual fund. </li></ul><ul><li>12b-1 Fee (or Distribution Fee) – annual charge deducted by a fund company from fund’s assets to pay for advertising, marketing, distribution, and promotion costs. </li></ul><ul><ul><li>Ongoing expenses that increases fund costs </li></ul></ul><ul><ul><li>Avoid funds with this charge (see prospectus) </li></ul></ul>
    22. 22. Disclosure of Fees <ul><li>Standardized Expense Table – illustrates in an identical manner the effects of a mutual fund’s fees and other expenses (hypothetical scenario) </li></ul><ul><li>Expense Ratio – the combined percentage (of fund assets) charged annually for expenses including management fees, 12b-1 fees, and other expenses of the mutual fund company. </li></ul>
    23. 23. What’s Best: Load or No-Load? Low-Fee or High-Fee? <ul><li>Up-front load charges are costly to investors in the short run (less than five years), </li></ul><ul><li>Annual 12b-1 charges are very costly over the long run (increase expense ratio) </li></ul><ul><li>Over five-year periods, lower-cost funds always deliver better returns than those offered by higher-cost funds. </li></ul><ul><ul><li>Funds with no 12b-1 fees </li></ul></ul><ul><ul><li>Index funds </li></ul></ul>
    24. 24. Managed Funds or Index Funds? <ul><li>Managed Funds – professional managers are constantly evaluating and choosing securities using a specific investment approach. </li></ul><ul><li>Index Fund – a mutual fund that buys and holds stocks or bonds that constitute a market index. </li></ul><ul><ul><li>Managers do not evaluate and select individual securities, but rather buy and hold all the stocks in a particular index. </li></ul></ul><ul><ul><li>Examples of market indexes? </li></ul></ul>
    25. 25. How to Evaluate Mutual Funds in Which to Invest <ul><li>Match your investment philosophy and financial goals to a mutual fund’s objectives </li></ul><ul><li>Read prospectuses and annual reports </li></ul><ul><ul><li>Annual Report – a published summary of the financial activities of a mutual fund company for the year. </li></ul></ul>
    26. 26. How to Evaluate Mutual Funds in Which to Invest (Continued) <ul><li>Locate sources of comparative performance data: </li></ul><ul><ul><li>The “Financial Press” (Examples?) </li></ul></ul><ul><ul><li>Specialized mutual fund investment publications (e.g., Morningstar Mutual Funds) </li></ul></ul><ul><ul><li>Magazines that rate mutual funds </li></ul></ul><ul><ul><li>Internet sources on mutual funds </li></ul></ul><ul><ul><ul><li> </li></ul></ul></ul><ul><ul><ul><li> </li></ul></ul></ul>
    27. 27. Figure 15.3: Balancing Risk and Returns on Mutual Funds
    28. 28. Interpret Comparative Performance Information Over Time <ul><li>Consider a fund’s volatility – a security’s or mutual fund’s tendency to rise or fall in price over a period of time. </li></ul><ul><li>Consider a fund’s long- and short-term performance </li></ul><ul><li>Consider a fund’s size </li></ul><ul><li>Consider a fund’s performance in up and down markets </li></ul>
    29. 29. Golden Rules of Investing in Mutual Funds <ul><li>Invest only in no-load mutual funds that have a low expense ratio and do not assess a 12(b)1 fee. </li></ul><ul><li>When choosing mutual funds, always match your investment philosophy and financial goals to a mutual fund’s objectives </li></ul><ul><li>When investing for long-term goals, definitely sign up for automatic reinvestment of your mutual fund dividends. </li></ul>
    30. 30. Golden Rules of Investing in Mutual Funds (Continued) <ul><li>If you have a defined contribution retirement plan available at work, sign up for payroll withholding to automatically forward a portion of each paycheck to a mutual fund. </li></ul><ul><li>Invest most of your “serious” money – such as to pay for a child’s education and retirement – in one or more low-fee diversified index funds. </li></ul><ul><li>Don’t jump in and out of the mutual fund market; instead, keep it simple by investing in a few funds and leave your money alone. </li></ul>