Chapter 15 Investing in Mutual Funds

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Chapter 15 Investing in Mutual Funds

• Mutual Funds
• Raise money by selling shares to the investing
  public
• Use these pooled funds to purchase various types
  of securities

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Chapter 15 Investing in Mutual Funds

• Mutual Funds
• INDIRECT INVESTMENT
• You own shares in the mutual fund company.
• The mutual fund owns the shares of the individual
  company stocks and bonds.

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Chapter 15 Investing in Mutual Funds

• Open-end Investment Funds
• Constantly issuing new shares and redeeming
  existing shares
• A buyer buys shares DIRECTLY FROM THE FUND
• A buyer redeems shares BACK TO THE FUND

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Chapter 15 Investing in Mutual Funds

• Mutual Funds
• Passes the income paid by securities in interest
  or dividends along to the shareholders
• Also passes the capital gain or loss (if
  security becomes more or less valuable) along to
  the shareholder

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Chapter 15 Investing in Mutual Funds

• Measuring Value of Mutual Funds
• NET ASSET VALUE important number for determining
  mutual funds worth
• Formula for computing
• Current market value of securities owned
• LESS liabilities
• Divided by number of outstanding shares

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Chapter 15 Investing in Mutual Funds

• Measuring Value of Mutual Funds
• If the current market value of securities owned
  is
• 53 million and there are
• 12 million shares,
• the NET ASSET VALUE is
• 53 million/ 12 million 4.42 per share
• As the market value changes, the funds net asset
  value changes as well.

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Chapter 15 Investing in Mutual Funds

• Buying Mutual Funds
• Can be purchased through a stockholder or
  directly from mutual fund
• Obtain a prospectus before purchasing which
  states
• Investment objectives of the fund
• Types of securities it purchases
• Recent performance
• Fees charged

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Chapter 15 Investing in Mutual Funds

• Services Offered by Mutual Funds
• Automatic Reinvestment of Distributions
• Automatic Investments
• Exchange Privileges
• Check Writing

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Chapter 15 Investing in Mutual Funds

• Automatic Reinvestment of Distributions
• Profits put back into your account. Increases
  the number of shares you own
• You can reinvest either
• Investment income (dividends and interest)
• Realized capital gains (selling a security for
  more than you paid for it)
• Excellent way to establish regular investment plan

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Chapter 15 Investing in Mutual Funds

• Exchange Privileges
• Funds often part of MUTUAL FUND FAMILY (different
  mutual funds offered by same company)
• Money can be transferred between funds within
  this family
• Transfers can be done by phone

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Chapter 15 Investing in Mutual Funds

• Check Writing
• Fund redeems enough shares to cover the checks
• Usually checks must be made for a minimum of 500
• These accounts do not replace function of bank or
  credit union checking account

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Chapter 15 Investing in Mutual Funds

• Mutual Fund Regulations
• Regulated by U.S. Securities and Exchange
  Commission (SEC)
• Determines information covered in prospectus
• Limits types of advertisements mutual funds can
  use
• Also subject to state approval

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Chapter 15 Investing in Mutual Funds

• Obtaining Mutual Fund Information
• Two of best-known rating services
• Morningstar
• CDA/Wiesenberger
• Also annual issues devoted to mutual funds in
• Money magazine
• Consumers Report

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Chapter 15 Investing in Mutual Funds

• Classifications of Mutual Funds
• Traditionally classified as
• 1. Stock funds
• 2. Bond or income funds
• 3. Money market funds

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Chapter 15 Investing in Mutual Funds

• Stock Funds
• Can be further categorized as
• Aggressive growth funds
• Growth and income funds
• Long-term growth funds
• Small company growth funds
• International funds

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Chapter 15 Investing in Mutual Funds

• Bond Funds
• Can be further categorized as
• Government funds
• High-yield corporate funds
• Investment-grade corporate funds
• Mortgage-backed securities funds
• Municipal bond funds
• World income funds

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Chapter 15 Investing in Mutual Funds

• Money Market Funds
• Can be further categorized as
• Government funds
• Taxable funds
• Tax-exempt funds

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Chapter 15 Investing in Mutual Funds

• Three Types of Mutual Funds Worth Noting
• Sector Funds
• Asset Allocation Funds
• Index Funds

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Chapter 15 Investing in Mutual Funds

• Asset Allocation Funds
• Classified as total return funds
• Invest in mixture of stocks, bonds, and money
  market instruments
• Percentage invested in each to produce
• High returns
• Less volatility

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Chapter 15 Investing in Mutual Funds

• Index Funds
• Attempts to replicate performance of a major
  stock index
• Standard Poors 500 most popular index
• Comprised of 500 large, well-known companies
• Considered one of best measures of overall stock
  markets

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Chapter 15 Investing in Mutual Funds

• Index Funds
• Investors do no better and also no worse than
  overall market
• Two reasons to invest
• Average stock fund has had difficulty beating
  overall stock market lately
• Low fees charged by funds

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Chapter 15 Investing in Mutual Funds

• Sector Funds
• Invest in only one industry (telecommunications,
  for example)
• Much more risky than other stock funds

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Chapter 15 Investing in Mutual Funds

• Advantages of Mutual Funds
• Three main reasons to invest in mutual funds
• 1. Diversification
• 2. Small minimum investment
• 3. Professional management

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Chapter 15 Investing in Mutual Funds

• Diversification
• Typical stock fund owns over 100 different common
  stocks
• Duplicating this diversification individually
  would necessitate
• HUGE investment of time
• HUGE investment of money
• However not all stocks funds are diversified.
  Read the prospectus.

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Chapter 15 Investing in Mutual Funds

• Smaller Minimum Investment
• Investor can purchase well-diversified portfolio
  for small investment
• Same amount of dollars would not allow individual
  to achieve this diversification
• Stock and bond mutual funds usually require
  initial investments between 1,000 and 3,000

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Chapter 15 Investing in Mutual Funds

• Professional Management
• Eliminates most time-consuming paperwork
• May include the preparation of some tax forms
• Managers make all the buy and sell decisions
• Although professionally managed, NO GUARANTEE THE
  FUND WILL ALWAYS PRODUCE SUPERIOR RESULTS

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Chapter 15 Investing in Mutual Funds

• Picking the Right Fund
• After choosing your goals, identify mutual fund
  most consistent with
• Your goals
• Your investment time horizon
• Expected return needed to meet your goals
• Your tolerance for risk

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Chapter 15 Investing in Mutual Funds

• Evaluating Fees and Expenses
• Three key points to remember in evaluating fees
  and expenses
• Substantial variation exists in operating
  expenses
• They can dramatically impact value of investment
  over time
• Evidence exists that higher fees affect
  performance adversely

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Chapter 15 Investing in Mutual Funds

• Historical Performance
• Perhaps single most important criterion for
  choosing between funds
• Reports on performance for evaluating funds
  include
• Type of fund and investment style
• Total return
• Relative performance
• Risk
• Overall rating

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Chapter 15 Investing in Mutual Funds

• Total Return
• Measures return over a period of time
• Takes into account
• Income received
• Changes in price
• To assess total return, examine performance
• Over varying period of time
• The longer time frame, the better

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Chapter 15 Investing in Mutual Funds

• Relative Performance
• Comparing mutual funds performance to a
  relative benchmark
• Best benchmark is market index comprised of type
  of securities in which the fund invests
• Can also compare performance of a mutual fund to
  other funds with similar objectives

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Chapter 15 Investing in Mutual Funds

• How Does Dollar Cost Averaging Work?
• Elise has 1,500 to invest. She is debating
  whether to invest the whole amount at one time
  (lump sum) or to invest in regular intervals over
  the next six months.
• If the price per share declines over time you can
  buy more shares. The opposite is also true.
• Remember the Time Value of Money Money today
  will be worth more in the future than payments

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Chapter 15 Investing in Mutual Funds

• Making Changes to Mutual Funds Investments
• Re-assessing investment goals as investor ages
• Rebalancing investments to
• Adjust income to maintain target asset allocation
• Re-adjust changing returns earned by different
  types of investments

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Chapter 15 Investing in Mutual Funds

• Warning Signs for Mutual Funds
• 1. Performance lags behind benchmarks for three
  consecutive years
• 2. Fund gets very LARGE very FAST
• Manager may run out of good investments
• Performance will subsequently suffer

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Chapter 15 Investing in Mutual Funds

• Warning Signs for Mutual Funds
• 3. Expenses keep rising
• Rising fees charged by funds trying to benefit
  from popularity
• Rising fees mean lower returns
• 4. Management turnover
• New managers investment philosophy may be
  different