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Chapter 16


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Chapter 16

  1. 1. Chapter 16 Investing in Mutual Funds McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
  2. 2. What is a Mutual Fund? <ul><li>An investment alternative where money from investors is pooled to buy stocks, bonds, and other financial securities selected by professional managers. </li></ul><ul><li>Many people choose mutual funds for their retirement account investments. </li></ul><ul><ul><li>401(k) or 403(b) </li></ul></ul><ul><ul><li>IRA </li></ul></ul><ul><ul><li>Roth IRA </li></ul></ul>16-2
  3. 3. Mutual Fund Statistics <ul><li>92 million individuals in 54 million households in the U.S. own mutual funds. </li></ul><ul><li>Over 8,000 mutual funds by 2004. </li></ul><ul><li>Over $8 trillion in assets owned by mutual funds in the U.S. by 2004. </li></ul>16-3
  4. 4. Why Investors Purchase Mutual Funds <ul><li>Professional management. </li></ul><ul><ul><li>Who is the fund’s manager? </li></ul></ul><ul><ul><li>Managers can change. </li></ul></ul><ul><ul><li>Be aware of the scandal involving late trading. </li></ul></ul><ul><li>Diversification. </li></ul><ul><ul><li>Investors funds are used to purchase a variety of investments. This variety provides some safety. </li></ul></ul>16-4
  5. 5. Closed- and Open-End Funds <ul><li>Closed-end funds (7% of funds). </li></ul><ul><ul><li>Shares are issued by an investment company only when the fund is organized. </li></ul></ul><ul><ul><li>After all original shares are sold you can purchase shares only from another investor who is willing to sell. </li></ul></ul><ul><ul><li>Traded on exchanges and over-the-counter. </li></ul></ul><ul><li>Open-end funds (91% of funds). </li></ul><ul><ul><li>Shares are issued and redeemed by the investment company at the request of investors. </li></ul></ul><ul><ul><li>Investors can buy and sell shares at the net asset value (NAV). </li></ul></ul>16-5
  6. 6. Exchange-Traded Funds <ul><li>Invests in the stocks contained in a specific stock market index, like the Standard and Poor’s 500 stock index. </li></ul><ul><li>Performance of shares in the fund tend to mirror the performance of the index. </li></ul><ul><li>Low management fees since there is less need for decisions made by a portfolio manager. </li></ul>16-6
  7. 7. Net Asset Value (NAV) <ul><li>Value of the fund’s portfolio - Liabilities </li></ul><ul><li>Number of shares outstanding </li></ul><ul><li>For most mutual funds, NAV is calculated at the close of trading each day. </li></ul>16-7
  8. 8. Load Funds and No-Load Funds <ul><li>Load Fund. </li></ul><ul><ul><li>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) </li></ul></ul><ul><ul><li>Average charge is 3-5% for which an investor can get purchase advice and explanations. </li></ul></ul><ul><li>No-Load Fund. </li></ul><ul><ul><li>Investors pay no sales charge up front. </li></ul></ul><ul><ul><li>You deal directly with the fund with 800 numbers or web sites, or from discount brokers. </li></ul></ul>16-8
  9. 9. Management Fees and Other Charges <ul><li>Contingent deferred sales load (back-end load) (Class B shares). </li></ul><ul><ul><li>Charged upon withdrawal of funds (1-5%). </li></ul></ul><ul><ul><li>Generally decreases on a sliding scale depending on the number of years shares are held. </li></ul></ul><ul><li>Management fee. </li></ul><ul><ul><li>Charged yearly (.5%-1.25% average) based on a percentage of the funds asset value. </li></ul></ul><ul><li>12b-1 fees (Class C shares). </li></ul><ul><ul><li>Annual fee to defray advertising and marketing costs of the fund. </li></ul></ul><ul><ul><li>1% or less of a fund’s assets per year. </li></ul></ul>16-9
  10. 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. 11. Classification of Mutual Funds <ul><li>Stock funds. </li></ul><ul><ul><li>Aggressive growth funds buy stocks in small, fast-growing companies. </li></ul></ul><ul><ul><li>Equity income funds invest in stock of companies with a long history of paying dividends. </li></ul></ul><ul><ul><li>Growth buy stock in companies with higher-than-average revenue and earnings growth. </li></ul></ul><ul><ul><li>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. </li></ul></ul><ul><ul><li>Index buys stocks that mirror an index . </li></ul></ul><ul><ul><li>Large-cap funds invest in companies with capitalization of $5 billion or more. </li></ul></ul><ul><ul><li>Mid-cap funds buy stock in companies whose capitalization is between $1 and $5 billion. </li></ul></ul>16-11
  12. 12. Classification of Mutual Funds <ul><ul><li>Regional funds buy stock in companies in a specific region of the world. </li></ul></ul><ul><ul><li>Sector funds buy stock in companies in a particular industry such as biotechnology. </li></ul></ul><ul><ul><li>Small-cap funds buy stock in lesser-known companies with a capitalization of less than 500 million. </li></ul></ul><ul><ul><li>Socially responsible funds avoid investing in companies that produce harmful products. </li></ul></ul>16-12 (continued)
  13. 13. Classification of Mutual Funds <ul><li>Bond funds. </li></ul><ul><ul><li>High-yield (junk) bond funds buy corporate bonds that are higher risk and higher yield. </li></ul></ul><ul><ul><li>Index bond funds invest in a sampling of bonds included in an index. </li></ul></ul><ul><ul><li>Intermediate corporate bonds (5-10 years). </li></ul></ul><ul><ul><li>Intermediate U.S. bond funds buy treasury notes with maturities of 5-10 years. </li></ul></ul><ul><ul><li>Long-term corporate bonds (> 10 years). </li></ul></ul>(continued) 16-13
  14. 14. Classification of Mutual Funds <ul><ul><li>Long-term U.S. bond funds: U.S. Treasury and U.S. zero-coupon bonds with maturities > than 10 years. </li></ul></ul><ul><ul><li>Municipal bonds: Invest in municipal bonds that provide investors tax-free interest income. </li></ul></ul><ul><ul><li>Short-term U.S. bond funds invest in U.S.Treasury issues of 1-5 years. </li></ul></ul><ul><ul><li>Short-term corporate bond funds: Investment grade bonds with maturities of 1-5 years. </li></ul></ul><ul><ul><li>World bond funds buy bonds of foreign companies and governments. </li></ul></ul>(continued) 16-14
  15. 15. Classification of Mutual Funds <ul><li>Other funds. </li></ul><ul><ul><li>Asset allocation funds: invest in various asset classes, such as stocks, and bonds, with precise amounts within each type. </li></ul></ul><ul><ul><li>Balanced funds: Invest in both stocks and bonds, with the primary objectives of conserving principal, providing income as well as growth. </li></ul></ul><ul><ul><li>Money market funds: Invest in CD’s, government securities, and other safe investments. </li></ul></ul>(continued) 16-15
  16. 16. Families of Funds <ul><li>A family of funds exists when one investment company manages a group of mutual funds. </li></ul><ul><li>Each fund in the family has a different financial objective. </li></ul><ul><li>Exchange privileges allow you to move your money from one fund to another within the fund family with little or no charge. </li></ul>16-16
  17. 17. Steps to Evaluate Mutual Funds <ul><li>Are you ready to invest in mutual funds? </li></ul><ul><li>Determine your risk tolerance. </li></ul><ul><li>Determine your investment objectives. </li></ul><ul><li>Obtain the money you need invest. </li></ul><ul><li>A fund’s objective should match your investment objective. </li></ul><ul><li>Evaluate any mutual fund before buying or selling ( ) </li></ul><ul><li>Consider managed funds vs. indexed funds </li></ul>16-17
  18. 18. Internet Sources of Fund Information <ul><li>Use web sites to research a fund. </li></ul><ul><ul><li>http:// </li></ul></ul><ul><ul><li> </li></ul></ul><ul><ul><li> (also other advisory services, such as Value Line). </li></ul></ul><ul><ul><li> </li></ul></ul><ul><li>Check mutual fund companies Internet sites. </li></ul><ul><ul><li> </li></ul></ul><ul><ul><li> </li></ul></ul>16-18
  19. 19. Reading a Mutual Fund Quote in the Newspaper <ul><li>Net asset value and asset value change. </li></ul><ul><li>The fund family and fund name. </li></ul><ul><li>Fund objective. </li></ul><ul><li>Total return over various time periods. </li></ul><ul><li>Ranking among funds with the same objective. </li></ul><ul><li>Sales load fees if any, or no load (NL). </li></ul><ul><li>Annual expenses. </li></ul>16-19
  20. 20. Other Sources of Fund Information <ul><li>Mutual fund prospectus tells the funds objective and: </li></ul><ul><ul><li>A statement describing the risk factors. </li></ul></ul><ul><ul><li>A description of the fund’s past performance. </li></ul></ul><ul><ul><li>A statement describing the type of investments in the fund’s portfolio. </li></ul></ul><ul><ul><li>Information on how to open an account. </li></ul></ul><ul><ul><li>Dividends, distributions and taxes. </li></ul></ul><ul><ul><li>Information about the fund’s management. </li></ul></ul><ul><ul><li>The process for investors to buy or sell shares. </li></ul></ul><ul><ul><li>Services provided to investors. </li></ul></ul><ul><ul><li>The turnover ratio of the fund’s investments. </li></ul></ul>16-20
  21. 21. Other Sources of Fund Information <ul><li>Mutual fund annual report. </li></ul><ul><ul><li>Performance, investments, assets and liabilities. </li></ul></ul><ul><li>Financial Publications. </li></ul><ul><ul><li>Business Week , Forbes , Kiplinger's Personal Finance and Money are sources of information. </li></ul></ul><ul><ul><li>Business Week’s mutual fund survey includes information such as the... </li></ul></ul><ul><ul><ul><li>Fund’s overall rating compared to all other funds, and to funds in the same category. </li></ul></ul></ul><ul><ul><ul><li>Fund size, sales charge and expense ratio. </li></ul></ul></ul><ul><ul><ul><li>Performance for best and worst quarters. </li></ul></ul></ul>16-21 (continued)
  22. 22. Mutual Fund Transactions <ul><li>You can open an account from $250 to $3,000 and up depending on the fund & family. </li></ul><ul><li>Open-end, no-load directly from the investment company by phone, mail, online, or from a discount broker. </li></ul><ul><li>Closed-end or exchange-traded funds are purchased through a broker; traded on stock exchanges and over-the-counter. </li></ul>16-22
  23. 23. Mutual Fund Transactions <ul><li>There are several ways you can get a return on your investment. </li></ul><ul><ul><li>Capital gains: sell shares at a price > than you paid (Report on Schedule D and 1040). </li></ul></ul><ul><ul><li>Income dividends: earnings funds pay to shareholders from dividend and interest income (Taxed as regular income). </li></ul></ul><ul><ul><li>Capital gain distributions: Payments to shareholders from sale of securities held by the fund (Show on Schedule D and 1040). </li></ul></ul><ul><ul><li>Income and capital gain distributions can be automatically reinvested. </li></ul></ul>16-23
  24. 24. Mutual Fund Features <ul><li>Automatic investments: Money is taken from your checking account monthly and invested in a fund. </li></ul><ul><li>Telephone Switching: Call your fund and move money from one fund to another in the same family. </li></ul><ul><li>Withdrawals: Various withdrawal options; you can withdraw funds by phone, letter, online, etc. </li></ul>16-24
  25. 25. Mutual Fund Activity <ul><li>Go online to , or other sources and do some research on mutual funds. </li></ul><ul><li>Find a fund that you feel would be a good investment for you. </li></ul><ul><li>Pair off with another student. Compare your mutual fund selections and discuss your investment objectives and how this fund will meet those objectives. </li></ul>16-25