ppt_ch15.ppt

Chapter Fifteen

Investing Through Mutual Funds

Copyright ©Houghton Mifflin Company. All rights reserved. 15 - 2

Learning Objectives

1. Summarize the two types of investment returns that investors expect from mutual funds.

2. Classify mutual funds by investment objectives.

3. Describe the unique features of mutual funds that make them an attractive investment.


Learning Objectives (continued)

4. Distinguish among load and no-load mutual funds and explain how to avoid some of their numerous charges and fees.

5. Explain how to evaluate mutual funds in which to invest.


Introduction

• Investment Company – a corporation, trust, or partnership in which investors with similar financial goals pool their funds so as to utilize professional management and to diversify their investments in securities and other investments.


Introduction (continued)

• Mutual Fund – an investment company that combines the funds of investors who have purchased shares of ownership in the investment company and then invests that money in a diversified portfolio of stocks and bonds issued by other corporations or governments.

• Portfolio – consists of a collection of securities and other investment alternatives.


What Investors Expect from Mutual Funds

• Closed-End Investment Company – issues a limited and fixed number of shares and does not buy them back.

• Open-End Mutual Fund – always ready to sell new shares of ownership and to buy back previously sold shares at the fund’s current share price.


Figure 15.1: How a Mutual Fund Works


Investors Expect Mutual Fund Dividend Income

• Mutual Fund Dividends – income paid to investors out of profits earned by the mutual fund from the investments it has made.– Mutual funds dividends represent current

income to mutual fund shareholders.


Ordinary Income Dividend Distributions

• Ordinary Income Dividend Distributions – the fund pays out dividend income and interest it has received from securities it owns.


Capital Gains Distributions

• Capital Gains Distributions – represent the net gains that a fund realizes when it sells securities that were held in the fund’s portfolio.


Investors Expect Capital Gains Through Price Appreciation

• Mutual fund investors also expect to profit when they sell their shares.

• Net Asset Value (NAV) – the per-share value of the mutual fund.

• Unrealized Capital Gains – merely “paper profits” on the accounts of the mutual fund.

• When such gains are “realized” by the mutual fund company, they are paid to fund investors as capital gains distributions.


Mutual Funds Have Different Investment Objectives

• Prospectus – a mutual fund’s investment objectives must be stated in this.


Funds with an Income Objective

• Bond Fund – aims to earn current income without incurring undue risk and to pay ordinary income dividend distributions.

• Municipal Bond (Tax-Exempt) Fund – attempts to earn current tax-exempt income by investing solely in municipal bonds issued by cities, states, and various districts and political subdivisions.

• Mortgage Fund – invests in mortgage-backed securities.


Funds with a Balanced Objective

• Balanced Funds – invest in a mixture of bonds, preferred stocks, and blue-chip common stocks.


Funds with a Growth Objective

• Growth Fund – seeks long-term capital appreciation by investing in the common stocks of companies whose values are expected to grow faster than usual.

• Value Fund – specializes in growth stocks whose prices appear to be low, based on the logic that such stocks are currently out of favor and under-priced.


Funds with a Growth Objective (continued)

• Aggressive-Growth Fund (or Maximum Capital Gains Fund) – seeks the greatest long-term capital appreciation and incurs the greatest fluctuation in the price of its shares.

• Small-Cap Fund (or Small-Capitalization Fund) – specializes in investing in lesser-known mid-sized companies with market capitalization of less than $1 billion that are expected to grow rapidly.



• Sector Fund – heavily invests in common stocks from one industry or one portion of the economy that are expected to grow, perhaps very rapidly.

• Precious Metals and Gold Funds – seek long-term capital appreciation by investing in securities associated with gold, silver, and other precious metals.

• Global Fund – invests primarily in growth stocks of companies listed on foreign exchanges.



• International Funds – hold only foreign stocks, and some such funds focus on a single country or geographic region.


Funds with a Growth and Income Objective

• Growth and Income Fund – objective is a combination of growth and income; invests in companies expected to show average or better growth and to pay steady or rising dividends.

• Life-Cycle Funds – create a diversified, all-in-one portfolio for those individuals who do not wish to actively manage their own investments.


Funds with a Growth and Income Objective (continued)

• Socially Conscious Funds – usually invest in firms with good records on the environment, human rights and public safety.

• Mutual Fund Funds – earn a return by investing in other mutual funds, thereby providing extensive diversification.


Unique Features of Mutual Funds

• Easy Purchase and Sale – after you have opened an account with a mutual fund company, you can easily buy and sell shares.

• Check Writing and Wiring of Funds• Automatic Investment – Most funds allow

investors to make periodic monthly or quarterly payments using money automatically transferred from their bank account to the mutual fund company.


Unique Features of Mutual Funds (continued)

• Automatic Reinvestment – allows for the automatic use of ordinary income dividend distributions, capital gains distributions, and interest to buy additional shares of the fund without paying any commissions.


Figure 15.2: The Wisdom of Automatic Reinvestment


Switching Privileges within a Mutual Fund Family

• Switching Privilege (or Exchange Privilege) – permits mutual fund shareholders to easily swap shares on a dollar-for-dollar basis for shares in another mutual fund within a mutual fund family.

• Exchange Fee – a small charge, typically $5 or $10 per transaction, on a transfer from one fund to another.

• Mutual Fund Family – exists when the same management company operates a variety of mutual funds, each with its own investment objectives.


Recordkeeping and Help with Taxes

• Confirmation Statements – indicate the number of shares owned and the value of the holdings.

• Consolidated Statements – report all of the investor’s holdings and transactions in the mutual fund family.


Beneficiary Designation

• Beneficiary Designation – enables the shareholder to name one or more beneficiaries so that the proceeds to go them without going through probate.


Withdrawal Plans

• Withdrawal Plans (or Systematic Withdrawal Plans) – available to shareholders who want a periodic income from their mutual fund investments.

• You can take your funds out of a mutual fund using one of four methods:– By taking a set dollar amount each month.– By cashing in a set number of shares each month.– By taking the current income as cash.– By taking a portion of the asset growth.


Mutual Fund Transaction Fees

• You may be required to pay a transaction fee when you purchase and sell your mutual fund shares

• Load funds always charge transaction fees – Sales Charge (or Commission or Load) –

assessed by some mutual funds at the time of purchase.

– Load Funds – mutual funds that levy sales charges.

– Front-End Load – the commission paid to the salesperson.


Mutual Fund Transaction Fees (continued)

• No-Load Funds Sometimes Charge Transaction Fees– No-Load Fund – a mutual fund that does

not assess a sales charge at the time of the investment purchase.

– Note that the SEC allows funds to be called “no-load” if they assess a “service fee” of 0.25 percent or less when shares are purchased.


Mutual Fund Transaction Fees (continued)

• Deferred Load (or Back-End Load) – a sales commission that is imposed only when shares are sold.

• Redemption Charge (or Exit Fee) – typically disappears after the investment has been held for six months or a year.


Mutual Fund Expense Charges

• Management Fee – an annual assessment to pay the advisors who operate the mutual fund.

• 12b-1 Fee (or Distribution Fee) – an annual charge deducted by the fund company from a fund’s assets to pay for advertising, marketing, distribution, and promotional costs.


Disclosure of Fees

• Standardized Expense Table – describes and illustrates in an identical manner the effects of all of a mutual fund’s fees and other expenses projected over five years.

• Expense Ratio – the combined percentage charged annually for expense charges including management fees, 12b-1 fees, and other expenses of the mutual fund company.


What’s Best: Load or No-Load? Low-Fee or High-Fee?

• Up-front load charges are costly to the investor in the short run (less than five years), whereas annual 12b-1 charges are very costly over the long run.

• Over five-year periods, lower-cost funds always deliver returns better than those offered by higher-cost funds.


Managed Funds or Index Funds?

• Managed Funds – professional managers are constantly evaluating and choosing securities using a specific investment approach.

• Index Fund – a mutual fund that simply buys and holds the stocks or bonds that constitute a market index.

• Unmanaged Funds – managers do not evaluate and select individual securities, but rather buy and hold all the stocks in a particular index.


How to Evaluate Mutual Funds in Which to Invest

• Match your investment philosophy and financial goals to a mutual fund’s objectives

• Read prospectuses and annual reports– Annual Report – a published summary of

the financial activities of a mutual fund company for the year.


How to Evaluate Mutual Funds in Which to Invest (continued)

• Locate sources of comparative performance data – The Financial Press– specialized mutual fund investment

publications– magazines that rate mutual funds– internet sources on mutual funds


Figure 15.3: Balancing Risk and Returns on Mutual Funds


Interpret Comparative Performance Information Over Time

• Consider a fund’s volatility – volatility characterizes a security’s or mutual fund’s tendency to rise or fall in price over a period of time.

• Consider a fund’s long- and short-term performance


Interpret Comparative Performance Information Over Time (continued)

• Consider the size of the fund

• Consider fund performance in up and down markets


Golden Rules of Investing in Mutual Funds

1. Invest only in no-load mutual funds that have a low expense ratio and also do not assess a 12(b)1 fee.

2. When choosing mutual funds, always match your investment philosophy and financial goals to a mutual fund’s objectives by gathering information about fund volatility and performance.

3. When investing for long-term goals, definitely sign up for automatic reinvestment of your mutual fund dividends.


Golden Rules of Investing in Mutual Funds (continued)

4. If you have a defined contribution retirement plan available at work, sign up for payroll withholding to automatically forward a portion of each paycheck to a mutual fund.

5. Invest most of your “serious” money – such as that to pay for your child’s education and your retirement – in one or more low-fee diversified index funds.


Golden Rules of Investing in Mutual Funds (continued)

6. Don’t jump in and out of the mutual fund market; instead, keep it simple by investing in a few funds and leave your money alone. That’s all.

Economy & Finance

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