1 C HAPTER 13 Investing in Mutual Funds a.k.a. Investment Companies, Investments for the Masses “Mutual Funds will bore you to wealth.” – Industry saying

2 What is a Mutual Fund? An investment chosen by people who pool their money to buy stocks, bonds, and other financial securities  a.k.a. Investment company (the legal term)  Professional management  Diversification Each fund has a specific objective Over 11,000 funds to choose from Many people choose mutual funds for their retirement account investments [401(k), 403(b), IRA and Roth IRA, etc.]

3 Mutual Funds STOCKS BONDSCASH Professional Money Management Diversification Stock mutual funds Bond mutual funds Money market mutual funds Balanced mutual funds a “mutual” fund (investment company)

4 Why Investors Purchase Mutual Funds Professional management  Who is the fund’s manager?  Managers change often (like professional athletes!)  Look for an experienced management team Diversification  Investors funds are pooled and used to purchase a variety of investments  This variety provides some safety that is difficult for individual investors to obtain on their own “PITA” factor is low – The Wealthy Barber

5 Growth of Mutual Fund Industry Year Number of Mutual Funds , , ,672 Source: Investment Company Institute 2016 Fact Book,

6 Mutual Fund Transactions Purchase options  Through a broker  Directly from the investment company  Best way is auto-contribution (payroll, checking)  Dollar-cost averaging! Sell options  Through a broker or through the mutual fund  Best way is auto-withdrawal (into your checking) You automatically invest $50 or $100 per month for thirty years and then you automatically withdraw $2,000 or $3,000 per month for the rest of your life! Sound interested? Uh, wait a minute. Did I mention that there are no guarantees? Always be sure to read the fine print, okay?

7 Mutual Fund Fees Annual operating expenses  Charged yearly based on a percentage of the fund’s asset value  How the mutual fund finances their operation  Range from <0.5% to 2%+ (50¢ to $2+ per $100)  Some have extremely low fees (index funds, ETFs) Sales loads (a.k.a. sales commissions)  Originally used to compensate the financial representative who sold the fund to the investor  Not all funds charge a commission – “No-load”  Careful! Some no-load funds have low fees; some have very high fees

8 Load Funds versus No-load Funds Types of Load Funds  Front-end Load – a.k.a. Class A  Upfront fee – lower annual operating expense  Back-end Load – a.k.a. Class B  Back-end fee – higher annual operating expense  No-load Funds (Huh?) – a.k.a. Class C  No upfront nor back-end fee – higher annual fees Types of No-Load Funds  Advisor No-load Funds – a.k.a. Class F, Class I  Advisor charges 1% to 2% to “manage the account”  “True” No-load Funds  May not have a 12b-1 fee greater than 0.25%  But that doesn’t mean the overall fees are low  Over time, a no-load fund can wind up costing more in fees than a load fund

9 Stock Mutual Funds  Aggressive Growth – most risky of stock funds  a.k.a. Momentum, Ultra  Growth – invests primarily in growth stocks (risky)  Capital Appreciation – very flexible, often very risky  Growth and Income – blend of growth & dividends  a.k.a. Value, Blend  Moderately risky  Equity Income – emphasizes dividends, least risky of stock funds Classification of Mutual Funds These classifications are just some of the major types of stock mutual funds. There are many, many more. Most risky Least risky

10 Stock Mutual Funds (continued)  Large Cap – largest companies  Mid Cap – medium-sized companies  Small Cap – smallest companies  Domestic – based in U.S.  Global – based anywhere in globe  International – based outside U.S.  Regional – Japan, Far East, Latin America, etc.  Sector – energy, technology, health care, etc. – dumb  Market Timing – dumber (continued) Which do you think is riskiest? Classification of Mutual Funds

11 Bond Mutual Funds  High-Yield Bonds (a.k.a. Junk Bonds)  Corporate Bonds  Municipal and Insured Municipal Bonds  State-specific municipal bond funds (exp: California)  U.S. Backed Bonds (Fannie Mae, etc.)  U.S. Bonds (Treasuries)  Long-term  Intermediate-term  Short-term  Domestic, Global, and International (continued) Classification of Mutual Funds What are the advantages / disadvantages of each of these types? Most risky bond funds Least risky bond funds

12 Classification of Mutual Funds Balanced Funds (a.k.a. Stock & Bond Funds)  Invest in both stocks and bonds  a.k.a. Asset allocation funds  Careful! Sometime very different than balanced  Often marketed as “a complete investment program for the prudent investor” Money Market Mutual Funds  Short-term investments (kinda’ like a checking acct) Mutual Funds of Mutual Funds – “Life-cycle”  “Huh? Sure, I don’t mind being charged twice!”  Often marketed as a total mutual fund solution  Retirement (401k), College Education, etc. (continued) Exhibit less risk than stock- only and bond-only funds

13 Classification of Mutual Funds Specialty Funds  Hedge Funds  Traditionally only open to “sophisticated investors ”  Very risky and sky-high operating expenses  “Bear” Funds  Expect market to go down  Precious Metals and Commodities Funds  REIT Funds  Boutique / Exotic Funds  StockCar Stocks Fund  Pauze Tombstone Fund  The Chicken Little Growth Fund (continued) The choices are endless. So are the fees…

14 The Buzz about Index Funds Index funds  No management (a.k.a. passively managed)  The mutual fund simply buys all the stocks in a specific index (S&P 500, “US Total Market”, EAFE)  Why?  Usually much lower annual operating expenses  Many actively managed funds don’t beat the indexes!  Unfortunately, index funds can become victims of their own success (Example: Vanguard Index 500) Many funds do beat the indexes  Look for a fund family where most all funds have consistently beaten the indexes over decades!  Psst! There are only a few companies!

15 The Buzz about ETF’s Exchange-Traded Funds  The success of index funds bred a whole new type of mutual fund  Traded on the exchanges like stocks  Very low annual operating expenses  Even lower than index funds  But you incur brokerage commissions  Most all are index funds (passively managed)  But there are now actively-managed ETF’s  Which have higher fees (because of the active management)  Can be bought and sold throughout the trading day  Unlike all other mutual funds which only trade at the end-of-trading-day closing price

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  Almost always with no charge  But, if in a taxable account, you could and probably will generate a taxable transaction “Choose a Family, Not a Fund”

17 Fund Families: Top Ten Families 1. Vanguard 2. American Funds (CR&M) 3. Fidelity 4. PIMCO 5. Franklin Templeton 6. T. Rowe Price 7. Columbia 8. BlackRock 9. JPMorgan 10. Oppenheimer Source: Bloomberg, Morningstar, Top Ten Mutual Fund Families Feb 2012Top Ten Mutual Fund Families Note: Other sources have the top 10 listed differently. Because of the mutual fund scandals of 2003, three of the companies that used to be amongst the top ten are no longer here. Examples: Offerings from the top three families

18 “Mutual Fund Scandals?!” “You want me to invest in an industry that is plagued with scandal?!”  Since 1940, the mutual fund industry has been regulated and escaped any hint of impropriety  In 2003, some practices that were not quite illegal but obviously unethical were uncovered  Only a handful of funds and people were affected  Strong, Janus, Bank of America, Putnum, Alliance  The vast majority of companies never engaged in the shenanigans Instead of losing $99,999 on a $100,000 account (example: Enron), investors lost $1 on a $100,000 account. Wait a minute, Paiano! Did you just say,

19 “So, How Do I Pick a Mutual Fund?” Pick a Mutual Fund that…  Invests in high-quality stocks or bonds  Is well-diversified across several industries and sectors of the economy  Has a long-term perspective and a manager or (better yet) a management team with many years of experience  Avoid companies that “shuffle” their managers every few years (which is virtually all of them!)  Has been around for decades and performed consistently well in both good and bad markets

20 A Sample Stock Mutual Fund Is 82 Years “Long-term” Enough? 6%, 8%, 9%, 10%? How ‘bout 12%?! “ But stocks have been very risky, right? ”  Short-term? Yes. Long-term? No! “ But now is not a good time to invest ”  What if you had invested on the worst day of the year for the past 20 years? “ But what about market downturns? ”  Keep a long-term perspective, and  Dollar Cost Average

21 Dollar Cost Averaging A system of buying an investment at regular intervals with a fixed dollar amount With Dollar Cost Averaging, there is always “Good News”  “The market is up! Good News!”  Your account is worth more  “The market is down! Good News!”  Next month, you will get more shares at a lower price when the $50 or $100 comes out of your paycheck or checking account Yippee! Huh?!

22 Hypotheticals Most mutual fund companies have a system for running “hypotheticals”  a.k.a. “Illustrations” “Hypothetical illustrations”  Examples of returns of investments  Lump sum principals, or  Streams of investments  a.k.a. Dollar-Cost Averaging  Or combinations of both lump sum & streams  Must be approved by SEC and FINRA  And contain disclaimers about past versus future performance Let’s run some hypotheticals!

23 And That’s Not the Only One! Do you remember this slide from chapter 1? As of December 31, 2015

24 Bottom Line on Mutual Funds Choose a fund family and stick with them  “Most mutual fund investors do worse than the mutual funds they invest in”  Re-evaluate them periodically  But make changes judiciously and sparingly  As you approach retirement, migrate from stock funds to bond funds  But don’t give up on stocks entirely (GFA illustration) Use Dollar Cost Averaging  $50 a month, $100 a month, whatever…  For the most part, Forget About Them!  I know. It makes investing boring, but it works!