1. Mutual Funds: An Easy Way to Diversify Professor Payne, Finance 4100
Chapter 14
Mutual Funds: An Easy Way to Diversify
Professor Payne, Finance 4100

2. Learning Objectives
Weigh the advantages and disadvantages of investing in mutual funds.
Differentiate between types of mutual funds, ETFs, and investment trusts.
Calculate mutual fund returns.
Classify mutual funds according to objectives.
Select a mutual fund that’s right for you.

3. Introduction A way of holding investments such as stocks and bonds.
Mutual fund—an investment that raises funds 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.

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

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

8. 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.

9. 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.

10. 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.

12. Investment Companies
Invest the pooled money of a number of investors in return for a fee
Most popular are the open-end investment companies or mutual funds
Net asset value (NAV)—dollar value of a share in the mutual fund

13. Investment Companies
Closed-End Investment Companies—can’t issue new shares
Unit Investment Trusts—fixed pool of securities
Real Estate Investment Trusts (REITs)—specializes in real estate
Hedge Funds—very risky

14. Calculating Mutual Fund Costs and Returns
Commissions when you buy or sell your holdings
Annual management fee
Marketing expenses

15. Load Versus No-Load Funds
Load—commission charged on a mutual fund
Load fund—mutual fund on which a load is charged.
Class A shares—front-end sales load
Class B shares—back-end load
Class C shares—pay coming and going
No-load fund—doesn’t charge commission

16. Management Fees and Expenses
Expense ratio—the ratio of a mutual fund’s expenses to its total assets
Invest in a fund with a low expense ratio
Turnover rate—measures the level of the fund’s trading activity.
Higher turnover rate, higher the fund’s expenses.

17. 12b-1 Fees
Annual fee, generally ranging from 0.25 to 1% of a fund’s assets, that the mutual fund charges its shareholders for marketing costs.

19. Calculating Mutual Fund Returns
Return can be in the form of dividends, capital gains, or a change in net asset value.
Automatic reinvestments result in increases in the NAV and number of shares.
Calculating returns can help you spot funds that have consistent winners over time.

20. Calculating Mutual Fund Returns

21. Types and Objectives of Mutual Funds
Fund managers classify their own funds
First, determine your objectives
Then, you can likely find a mutual fund to meet your objectives

22. Money Market Mutual Funds
Invest in Treasury bills, CDs, and other short-term investments, less than 30 days
Carry no loads, trade at a constant $1 NAV, and have minimal expense ratios
Tax-exempt money market fund
Government securities money market mutual fund

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

25. 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

26. Asset Allocation Funds
Invests in stocks, bonds, and money market securities
Move money between stocks and bonds to outperform the market
Balanced funds that practice market timing

27. 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

28. 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

29. U.S. Government Bond Funds or GNMA Bond Funds
Municipal Bond Funds
Corporate Bond Funds
Bond Funds and Their Maturities:
Short-term (1-5 years)
Intermediate-term (5-10 years)
Long-term (10-30 years)

30. Exchange Traded Funds or ETFs
A hybrid between a mutual fund and an individually traded stock or bond that trade on an exchange like individual securities do and can be bought and sold through the trading day.

31. Exchange Traded Funds or ETFs
Charge lower annual expenses but still pay trading commissions.
More tax-efficient than most mutual funds.
Allow investors to stake out an investment position in a sector, industry, or country.
Investors can make their move during the market’s trading hours.

34. Mutual Fund Services Automatic investment and withdrawal plans
Automatic reinvestment of interest, dividends, and capital gains
Wiring and funds express options
Online and phone switching
Easy establishment of retirement plans
Check writing
Bookkeeping and help with taxes

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

36. Buying a Mutual Fund Step 2: Meeting Your Objectives
Look at classifications and objectives

38. Buying a Mutual Fund Step 3: Selecting the Fund
Evaluate past performance and scrutinize the costs
Make sure it meets your objectives

43. 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 & Co.

44. Summary
When you buy a mutual fund, you’re buying a share of a very large portfolio which goes up and down as the value of the mutual fund’s investments goes up and down.
There are open-end and closed-end investment companies, unit investment trusts, and real estate investment trusts.

45. Summary
Be very wary of mutual fund expenses—no-load mutual funds don’t charge commission.
Funds are classified according to objective.
When selecting a mutual fund, determine your goals, find funds that meet your objectives, and evaluate.

46. End of Chapter 14 Slides