CHAPTER 13: INVESTING IN MUTUAL FUNDS

Mutual Fund Basics INVESTORS pool their money and

Mutual Fund Basics INVESTORS pool their money and buy shares in the MUTUAL FUND. ABC XYZ MUTUAL FUND

Mutual Fund Basics INVESTORS pool their money and buy shares in the MUTUAL FUND. ABC XYZ MUTUAL FUND FUND MANAGER selects and purchases a variety of investment instruments.

Advantages of Mutual Funds: Diversification—risk is lowered; one share buys a slice of everything in the fund. Professional management—pay someone else to make investing decisions. Financial returns—relatively attractive returns over the long term. Convenience—easy in & out, small outlays, help with record keeping.

Disadvantages of Mutual Funds: No choice in securities selection— if you don’t agree with choices, you must change funds. No control over sale of securities within fund—timing of sales has tax implications for investor.

How Mutual Funds are Organized: Each fund is a separate corporation or trust and is owned by the shareholders. Other main players include: Management company—runs the daily operations. Investment advisor—oversees portfolio. Distributor—sells fund shares. Custodian—physically safeguards fund’s assets. Transfer agent—executes transactions and maintains shareholder records.

Types of Investment Companies: Open-End Investment Companies (mutual funds) Dominant type of investment company Shares purchased from and sold back to company. Shares are not traded among individual investors. New shares issued as money flows in. NAV is usually the quoted price.

Net Asset Value (NAV) Current value of all securities held in fund’s portfolio. Open-end funds buy back their own shares at NAV. NAV = Current market price of all fund assets (Less any liabilities) Divided by the number of outstanding shares

Closed-End Investment Companies Operate with a fixed number of shares outstanding. All trading is done between investors on the open market. Shares frequently trade at a discount or premium to net asset value.

Exchange-Traded Funds Typically structured as index funds. Spiders based on S&P 500 Diamonds based DJIA Qubes based on Nasdaq 100 Trade on listed exchanges like closed-end funds. Numbers of shares outstanding can be increased or decreased, depending on demand, like open-end funds.

Unit Investment Trusts Usually sold by brokerage houses. Investors purchase a share in an unmanaged pool of investments. No trading of securities within the portfolio once the trust assets have been purchased. Tend to have relatively high transaction costs and yearly fees.

Real Estate Investment Trusts (REITs) Closed-end investment companies whose trust assets are limited to real estate investments. Offer a more diverse and marketable way to invest in real estate. Equity or property REITs invest in properties; mortgage REITs invest in mortgages; hybrid REITs invest in both.

Mutual Fund Cost Considerations: Loads = sales commissions Front-end load funds (or simply "load funds") charge a commission when shares are purchased. Low-load funds hold commissions to 2–3% when shares are purchased. Back-end load funds charge a commission when shares are sold.

No-Load Funds—no fee to purchase or redeem shares and low or no 12(b)-1 fees. 12(b)-1 Fees—annual fees for marketing and promotion. Management Fees—annual fees charged by all funds to pay the fund manager.

Maximum allowable fees: Total sales charges and fees cannot exceed 8 1/2%. Of this amount, 12(b)-1 fees cannot exceed 1%. Funds cannot call themselves “no-load” if their 12(b)-1 fees exceed 0.25%.

Keep Track of Fees! Funds are required to disclose all fees in their prospectus. Even no-load funds can have high annual expense ratios and/or 0.25% 12(b)-1 fees. Fees affect your return, and annual fees will be collected regardless of the performance of the fund.

Types of Funds Growth Aggressive Growth Value Equity-Income Balanced Growth & Income Bond Money Market Index Sector Socially Responsible International Asset Allocation

Services Offered by Mutual Funds: Automatic Investment Plan—mutual fund periodically drafts money from investor's bank account. Automatic Reinvestment Plan—fund earnings and distributions automatically reinvested in additional shares of fund. Regular Income—fund automatically pays out to investor predetermined amount periodically.

Conversion Privileges—allow shareholders to easily move from one fund to another within the fund family. Retirement Plans—funds set up and administer retirement plans for self-employed individuals.

Making Mutual Fund Investments Selecting a Mutual Fund: Match the fund's objectives with your investment objectives. Consider your tolerance for risk and your investment time horizon. Read the prospectus!

Assess the fund's services. Check the fees charged. Consider the fund's longer-term returns as well as its shorter-term returns. Refer to Exhibit 13.8 concerning mutual fund facts every investor should know.

Mutual Fund Performance: Returns consist of : 1) dividend/interest income earned by the fund assets; 2) realized capital gains distributions from sale of assets within the fund; 3) change in mutual fund's share price. Past performance reveals success of fund managers but does not guarantee future returns!

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