Mutual Funds: An Easy Way to Diversify Chapter 15 Mutual Funds: An Easy Way to Diversify

Introduction A way of holding investments such as stocks and bonds. Mutual fund—an investment that raises from investors, pools the money, and invests it in stocks, bonds, and other investments. Each investor owns a share of the fund proportionate to his/her investment.

Why Invest in Mutual Funds? Advantages of mutual funds: Professional management Minimal transaction costs Liquidity Flexibility Service Avoidance of bad brokers

Why Invest in Mutual Funds? Disadvantages of mutual funds: Lower-than-market performance Costs Risks You can’t diversity away a market crash Taxes

Mutual Fund-Amentals A mutual fund pools money from investors with similar financial goals. You are investing in a diversified portfolio that’s professionally managed according to set goals. Investment objectives are clearly stated.

Mutual Fund-Amentals As the value of the securities in the fund increases, the value of each mutual fund share also rises. Most pay dividends or interest to shareholders. Shareholders receive a capital gains distribution when the fund sells a security for more than originally paid.

Mutual Fund-Amentals Fund is set up as a corporation or trust. Shareholders elect a board of directors. Fund is run by a management company. Each individual fund hires an investment advisor to oversee the fund. Contracts with a custodian, a transfer agent, and an underwriter.

Table 15.2 Different Mutual Fund Costs

Stock Mutual Funds Aggressive growth funds Small company growth funds Growth-and-income funds Sector funds Index funds International funds

Balanced Mutual Funds Tries to balance objectives of long-term growth, income, and stability Hold both common stock and bonds and sometimes preferred stock Aimed at those needing income to live on and moderate stability in their investment Less volatile than stock mutual funds

Life Cycle and Target Retirement Funds Mutual funds that try to tailor their holdings to the investor’s individual characteristics, such as age and risk. Target retirement funds are managed based on when you plan to retire.

Bond Funds Mutual funds that invest primarily in bonds Fluctuate in value with market interest rates Use for small amounts of money, to keep investments liquid Otherwise, use individual bonds where there is no professional management or fees

Bond Funds U.S. Government Bond Funds of GNMA Bond funds Municipal Bond Funds Corporate Bond Funds Bonds and their maturities: Short-term (1-5 years) Intermediate-term (5-10 years) Long-term (10-30 years)

Buying a Mutual Fund Step 1: Determining Your Goals Goals and time horizon Why are you investing? Tax-deferred investments? Risk tolerance

Buying a Mutual Fund Step 2: Meeting Your Objectives Look at (sub)classifications and objectives. Morningstar provides an investment style box to understand the investment style.

Buying a Mutual Fund Step 3: Evaluating the Fund Where to look—sources of information Mutual fund prospectus Internet screening to find the right mutual fund

Table 15.6 What’s in a Mutual Fund Prospectus?

Buying a Mutual Fund Step 4: Making the Purchase Buy direct – use phone or internet. Buy through a mutual fund “supermarket”– such as Fidelity or Charles Schwab.