Mutual Funds Financial Literacy

2 What We Will Cover What is a Mutual Fund? Advantages and Disadvantage of Mutual Funds Costs of Mutual Funds Types of Mutual Funds ETFs Buying a Mutual Fund

3 What is a Mutual Fund? Investors pool their money A fund manager buys a variety of stocks Each investor owns a share of the fund (the total of all the stocks in the fund) When the fund increases in value, the investor makes money

4 How Mutual Funds Work Many investors (hundreds or thousands) put their money into the mutual fund pool. A professional manager will pick the stocks and bonds to buy

5 Net Asset Value Mutual funds do not change price during the trading day The price you buy and sell for is called net asset value (NAV) rather than stock price It is updated only once a day, at the end of the trading day Formula for NAV is: Total value of securities minus debts divided by number of shares

6 Open-Ended Funds This type of fund may issue as many shares as it wishes, and anyone can invest 95% of funds are open-ended

7 Closed-End Funds Closed-end funds can issue a limited number of shares Investors buy and sell shares among themselves

8 Advantages of Mutual Funds Diversification You purchase a small amount of many stocks without having to physically buy each stock Professional Management Fund managers are professionals with access to better information than the average investor

9 Advantages of Mutual Funds Minimal transaction costs Individual investors save on brokerage fees compared to individual stock purchases. In a retirement account there is no brokerage fee Liquidity Easy to buy and sell Flexibility There are over 8000 funds to choose from, allowing you to invest in an area you want

10 Disadvantages of Mutual Funds Lower-than-market performance On average, mutual funds underperform the market Costs Always charge an annual fee May also charge a sales fee These fees will eat away your profits

11 Disadvantages of Mutual Funds Risk Depending on the segment of the market the mutual fund invests, it may do very well or very poorly Systemic Risk A market crash will have a negative effect on your fund

12 Costs of Mutual Funds “Load” funds charge a commission to buy or sell the funds Usually 4-8% of the investment “Front-end load” means you pay a commission when you buy “Back-end load” means you pay a commission when you sell the fund

13 Costs of Mutual Funds “No-load” funds mean you don’t pay a sales commission Some funds will charge a fee if you sell within a specific period of time, such as 90 days

14 Costs of Mutual Funds Owners of mutual funds pay an annual expense Known as the expense ratio Typically it is.25 to 2 percent of the investment value Try to buy a fund with the lowest expense ratio (annual fee) possible Expenses can eat up all or most of your profits, especially if the fund isn’t performing well

Costs of Mutual Funds Annual fee You will have to pay an annual fee even if your mutual fund did not make money that year 15

Costs of Mutual Funds Taxes Generally you will have to pay taxes on the profits every year, except in a retirement account 16

17 Costs of Mutual Funds 12b-1 fee These are marketing expenses passed on to the investor They do not benefit the investor at all Try to find funds that have minimum or no 12b-1 fees They will eat into your profits and do not provide any benefit to the investor

18 Types of Mutual Funds Stock funds Most popular types of funds These funds invest mostly in stocks, but may also invest in cash, bonds, and money market funds

19 Types of Stock Funds Aggressive Growth Funds The fund buys stocks that will (hopefully) increase dramatically in price Very volatile Small-Company Growth Funds Investments are limited to small companies Volatile

20 Types of Stock Funds Income Funds Concentrate more on strong companies paying dividends (the dividends are the “income” in income funds) Less risky than aggressive growth funds Growth-and-Income Funds Concentrate on stocks providing dividends plus the potential for growth Less volatile

21 Types of Stock Funds Sector Funds Specializes in stocks from a specific industry Computer, financial services, biotech precious metals, etc. International Invests mostly in stocks outside the U.S.

22 Types of Mutual Funds Balanced funds Holds both stocks and bonds Asset Allocation Balanced funds with market timing

Types of Mutual Funds Life Cycle Funds (relatively new) Attempt to tailor holdings to the investor’s age and risk tolerance The fund is managed based on how close you are to retirement 23

24 Types of Mutual Funds Bond funds Invest in bonds rather than stocks Emphasize income over growth Types of bond funds (remember than when you buy a bond, you are actually lending money to the company or the government) U.S. Government bonds Municipal bonds (bonds issued by city or state) Corporate bonds (from a company)

Index Funds Index funds will directly mirror an index: DOW (DIA and others) S & P 500 (SPX and others) Nasdaq (QQQ and others) Inverse index funds will directly mirror the opposite of the market 25

26 ETFs (Exchange Traded Funds) ETF’s are available for any segment of the market, just as mutual funds are Lower expenses than mutual funds

ETF’s There are also inverse ETF’s which will make you money when the market goes down However, you will lose money when the market goes up 27

28 Buying a Mutual Fund Determine your goals What are you investing for? Retirement Education Income Growth Meeting your objectives Make sure the fund meets your goals (above)

29 Evaluate the Fund identifies funds by investment strategy and management stylewww.morningstar.com Look closely at past performance and expenses Compare funds in the same category; do not compare a growth fund to an international fund, for example Look for “star” ratings (4-star and 5-star ratings)

30 Buying a Mutual Fund You can purchase through your company’s 401(k) website You can purchase directly from the mutual fund company You can purchase from your broker You can purchase through your bank Many funds will let you invest with as little as $100 in a retirement account