© 2008 Thomson South-Western

CHAPTER 13

INVESTING INMUTUAL FUNDS

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The Mutual Fund Concept

Pooled diversification– Process whereby investors buy into

a diversified portfolio of securities for the collective benefit of individual investors

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The Mutual Fund Concept

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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 and out, small outlays, help with record keeping.

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Dis-Advantages of Mutual Funds

No choice in securities selection No control over sale of securities

within fund Management and other fees

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Comparative Performance of Mutual Funds for the 12-year period through 2005

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How Mutual Funds are Organized and Run

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.

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– Current value of all securities held in fund’s portfolio.

– Open-end funds buy back their own shares at NAV.

Net Asset Value (NAV)

NAV =

Current market price of all fund assets

(Less any liabilities)

Divided by the number of outstanding shares

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Mutual Fund Cost Considerations

Load Funds – Load = sales commission

– 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.

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12(b)-1 Fees—annual fees for marketing and promotion.

Management Fees—annual fees charged by all funds to pay the fund manager.

No-Load Funds—no fee to purchase or redeem shares and low or no 12(b)-1 fees.

Mutual Fund Cost Considerations

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Buying and Selling Funds

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Types of Funds

Growth Aggressive

Growth Value Equity-Income Balanced Growth & Income Bond

Money Market Index Sector Socially

Responsible International Asset Allocation

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Bond Funds

Government bond funds Mortgage-backed bond funds High-grade corporate bond funds High-yield corporate bond funds Convertible bond funds Municipal bond funds Intermediate-term bond funds

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Money Market Mutual Funds

General-purpose money funds Tax-exempt money funds Government securities money funds All highly liquid, low risk

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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.

Services Offered by Mutual Funds

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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

Stick with No Loads or Low Loads – load funds that produce superior returns are the exception rather than the rule.

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Investing in Real Estate

Investing in real estate provides greater diversification properties than does holding just stocks or bonds.

Typically exhibits less volatility than stocks, and it doesn’t move in tandem with stocks.

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Basic Considerations of Investing in Real Estate

Cash flow and taxes– Depreciation write-offs reduce taxes– Passive investment

Appreciation in value Use of leverage

– Using borrowed money to magnify returns

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Investing in Income Property

Commercial property Residential property Single-family homes

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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 REITs invest in properties• Mortgage REITs invest in mortgages• Hybrid REITs invest in both

Other Ways to Invest in Real Estate

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• Mortgage-backed securities• Ownership in a pool of mortgage

loans• GNMA (Ginnie Mae)• FNMA (Fannie Mae)

Other Ways to Invest in Real Estate