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INVESTING IN MUTUAL FUNDS

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INVESTING IN MUTUAL FUNDS Mutual Fund Basics Advantages of Mutual Funds: Diversification risk is lowered; one share buys a slice of everything in the fund. – PowerPoint PPT presentation

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Title: INVESTING IN MUTUAL FUNDS


1
INVESTING INMUTUAL FUNDS
2
Mutual Fund Basics
INVESTORS pool their money and
buy shares in the MUTUAL FUND.
FUND MANAGER selects and purchases a variety of
investment instruments.
3
Advantages of Mutual Funds
  • Diversificationrisk is lowered one share buys a
    slice of everything in the fund.
  • Professional managementpay someone else to make
    investing decisions.
  • Financial returnsrelatively attractive returns
    over the long term.
  • Convenienceeasy in out, small outlays, help
    with record keeping.

4
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.

5
  • Net Asset Value (NAV)
  • Current value of all securities held in funds
    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
6
  • 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.

7
  • Exchange-Traded Funds
  • Typically structured as index funds.
  • Spiders based on SP 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.

8
  • 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.

9
  • 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.

10
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 23 when
    shares are purchased.
  • Back-end load funds charge a commission when
    shares are sold.

11
  • No-Load Fundsno fee to purchase or redeem shares
    and low or no 12(b)-1 fees.
  • 12(b)-1 Feesannual fees for marketing and
    promotion.
  • Management Feesannual fees charged by all funds
    to pay the fund manager.

12
  • 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.

13
  • 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.

14
Types of Funds
  • Growth
  • Aggressive Growth
  • Value
  • Equity-Income
  • Balanced
  • Growth Income
  • Bond
  • Money Market
  • Index
  • Sector
  • Socially Responsible
  • International
  • Asset Allocation

15
Services Offered by Mutual Funds
  • Automatic Investment Planmutual fund
    periodically drafts money from investor's bank
    account.
  • Automatic Reinvestment Planfund earnings and
    distributions automatically reinvested in
    additional shares of fund.
  • Regular Incomefund automatically pays out to
    investor predetermined amount periodically.

16
  • Conversion Privilegesallow shareholders to
    easily move from one fund to another within the
    fund family.
  • Retirement Plansfunds set up and administer
    retirement plans for self-employed individuals.

17
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!

18
  • 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.

19
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!

20
MEETING RETIREMENT GOALS
21
Pitfalls in Retirement Planning
  • Starting too late.
  • Putting away too little.
  • Investing too conservatively (especially when you
    are younger).

22
Retirement Planning
1. Set Your Goals
  • At what age do you want to retire?
  • Start early in your career devoting money toward
    your retirement goals.

23
2. Estimate Your Needs
  • Determine household expenditures.
  • Estimate income.
  • Consider the effects of inflation.
  • Decide how you will provide for the difference
    between income and needs.

24
3. Establish Investment Program
  • Create systematic savings plan.
  • Identify appropriate investment vehicles.
  • Consider tax implications.
  • Develop investment plan.

25
Sources of Retirement Income
Other
Pensions
Government Assistance, including Social Security
Income-Producing Assets
Government still provides the largest portionrigh
t now.
26
Social Security
  • Benefits are provided by payroll taxes you and
    your employer pay (you pay both halves if you are
    self-employed).
  • Amount of benefits may be insufficient by the
    time you retire.
  • Think of it as an insurance system rather than a
    retirement plan.

27
Why SS may be in trouble
  • The number of people retiring is increasing.
  • The number of people who work and pay taxes for
    retirement benefits is decreasing.
  • Eventually more money may be flowing out of the
    system than is flowing in.

28
Pension PlansandRetirement Programs
  • Employer-sponsored retirement programs
  • Self-directed retirement programs

29
Employer-Sponsored Programs
  • Participation requirements are you eligible to
    participate in the program?
  • Contributions am I required to contribute to my
    own plan or not?
  • Vesting how long before I can take the money
    with me if I leave?
  • Retirement age when can I retire?
  • Qualifying does it qualify for tax
    deductibility?

30
Defined Benefit vs. Defined Contribution Plans
  • Defined Contribution company guarantees a
    contribution, but not a return on the
    contribution or a retirement benefit.
  • Defined Benefit company guarantees the benefit
    in retirement despite good or bad performance of
    the pension fund.

31
Supplemental Plans Allow employees to increase
retirement funds. These plans are often
voluntary, and contributions may be tax
deductible.
  • Profit-sharing plans employees benefit from
    company's earnings.
  • Thrift and savings plans employer contributes
    to employee's fund. Employee contributions NOT
    deductible.
  • Salary reduction plans employee contributes
    part of salary contributions tax deductible
    employer may also contribute as in a 401(k), 457,
    or 403(b).

32
Self-Directed Retirement Programs Allow
individuals and the self-employed to set up
tax-deferred retirement plans for themselves and
their employees.
  • Keogh Plans for professionals or small business
    owners and employees.
  • SEP Plans for professionals or small business
    owners with few or no employees simple to
    administer.
  • IRAs for any working American other
    self-directed plans may allow greater
    contributions.

33
Types of IRAs Each year, you must EARN at least
as much as you contribute to an IRA.
  • Traditional Tax-Deductible IRA for those with
    no employer-sponsored plan or with incomes below
    a certain level.
  • Traditional Non-Deductible IRA for those with
    an employer-sponsored plan and incomes over a
    certain level.
  • Roth IRA contributions not deductible for
    those with incomes below a much higher level,
    regardless of employer-sponsored plans.

34
More on IRAs
  • Maximum total yearly contribution to all IRAs
    combined is 4000 (as of 2005) or your earned
    income (whichever is less).
  • Non-working spouse can also contribute up to
    4000 (as of 2005).
  • An IRA is not an investment it is a
    tax-sheltered account. A variety of types of
    investments (ex bank CDs, mutual funds) can be
    held in an IRA account.
  • Returns on your IRA depend on your choice of
    investments.

35
Coverdell Education Savings Accounts
  • Earnings grow tax free for future education costs
    of a child or grandchild.
  • Contributions are NOT deductible, but withdrawals
    are tax and penalty free for qualified expenses.
  • Withdrawals must be made by the time beneficiary
    is age 30.
  • 2000 (as of 2003) maximum yearly contribution.

36
For Qualified Retirement Plans in General
  • Contributions grow tax free.
  • If contributions were initially tax deductible,
    money taxed as current income when withdrawn.
  • In general, you must be 59 1/2 to start taking
    distributions.
  • Early withdrawals are subject to a 10 penalty
    plus income taxes.
  • When moving accounts, have transfer made directly
    from one custodian to another.

37
Annuities
  • Tax-sheltered investment vehicles administered by
    life insurance companies.
  • An agreement to make contributions now in return
    for a series of payments later.
  • Contributions NOT tax deductible.

38
Expected amounts, Plug in expected return and
standard deviation. See ranges.
  • Long range probability estimates
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