chapter 15 investing through mutual fund

7/29/2019 Chapter 15 Investing Through Mutual fUND

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Chapter Fifteen

Investing Through

Mutual Funds


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

Learning Objectives

1. Summarize two types of investment returns thatinvestors expect from mutual funds.

2. Classify mutual funds by investment objectives.3. Describe unique features of mutual funds that

make them attractive.

4. Distinguish among load and no-load mutual funds5. Explain how to avoid various charges and fees.

6. Explain how to evaluate mutual funds to invest in.


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Introduction

Investment Company corporation, trust,or partnership in which investors with similarfinancial goals pool their money to...

utilize professional management

diversify their investments

What are some large mutualfund investment companies?


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Introduction (Continued)

Mutual Fund an investment company that

combines the funds of investors who havepurchased shares of ownership

invests that money in a diversified portfolio of

stocks and bonds issued by other corporationsor governments.

Portfolio consists of a collection of securitiesand other investment alternatives.


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Types of Investment Companies

Closed-End Investment Companyissues a limited and fixed number ofshares and does not buy them back.

Shares trade like stock on stock exchanges

Open-End Mutual Fund always readyto sell new shares of ownership and buyback previously sold shares at the funds

current share price. More than 90% of all mutual funds


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Figure 15.1: How a Mutual Fund Works


7/30Copyright Houghton Mifflin Company. All rights reserved. 15 - 7

Investors Expect Mutual Fund Dividendand Capital Gains Income

Mutual Fund Dividends income paid toinvestors out of profits earned by the mutualfund from the investments it has made.

Mutual funds dividends represent currentincome to mutual fund shareholders.

Capital Gains Distributions represent

net gains that a fund realizes when it sellssecurities held in the funds portfolio.

Recommended strategy:reinvestdividends andcapital gains into additional shares.



Investors Expect Capital GainsThrough Price Appreciation

Mutual fund investors also expect to profit whenthey sell their shares.

Net Asset Value (NAV) the per-share value of amutual fund.

Example: $52,500,000 value of fund

3,500,000 number of shares = $15 per share

UnrealizedCapital Gainsmerely paper profitson securities in the mutual fund.

When such gains are realized by the fund, they

are paid to investors as capital gains distributions.



Mutual Funds Have DifferentInvestment Objectives

Prospectusa mutual funds investmentobjectives must be stated in this.

Two Types:

Traditional prospectus (long) Profile prospectus (short)



Funds with an Income Objective

Bond Fund aims to earn current incomewithout incurring undue risk and to payordinary income dividend distributions.

Municipal Bond (Tax-Exempt) Fund

attempts to earn current tax-exempt incomeby investing solely in municipal bonds issuedby cities, states, and political subdivisions.

Mortgage Fund invests in mortgage-backed securities (e.g., Ginnie Maes)



Funds with a Balanced Objective

Balanced Funds invest in a mixtureof bonds, preferred stocks, and blue-chip common stocks.

Often 60% stocks, 40% bondsOften have the word balanced

in fund name



Funds with a Growth Objective

Growth Fund seeks long-term capitalappreciation by investing in the commonstocks of companies whose values are

expected to grow faster than usual.

Value Fund specializes in growthstocks whose prices appear to be low,

based on the logic that such stocks arecurrently out of favor and under-priced.



Funds with a Growth Objective(Continued)

Aggressive-Growth Fund (or Maximum CapitalGains Fund) seeks greatest long-term capitalappreciation and incurs greatest fluctuation in price.

Small-Cap Fund (or Small-Capitalization Fund)specializes in investing in smaller companies withmarket capitalization less than $1 billion.

Sector Fund heavily invests in common stocks

from one industry or one portion of the economy.

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



Funds with a Growth Objective(Continued)

Global Fund invests primarily ingrowth stocks of companies listed onforeign and U.S. exchanges.

International Funds hold only foreignstocks, and some such funds focus on asingle country or geographic region.



Funds with a Growth and IncomeObjective

Growth and Income Fund objective is acombination of growth and income; investsin companies expected to show average or

better growth and pay steady or risingdividends.

Life-Cycle Funds create a diversified, all-

in-one (stocks, bonds, and cash assets)portfolio for those individuals who do notwish to actively manage their investments.



Other Types of Funds

Socially Conscious Funds funds that aimto invest in firms with good records on theenvironment, human rights, and public safety.

Screen for various negative factors (e.g.,smoking, alcohol, polluters, gambling)

Funds of Funds funds that earn a return

by investing in other mutual funds, therebyproviding extensive diversification.



Unique Features of Mutual Funds

Easy Purchase and Sale after opening anaccount, you can easily buy and sell shares

Easy Access- check Writing and wiring of funds

Automatic Investment Most funds allowinvestors to make periodic (monthly or quarterly)payments using money automatically transferredfrom a bank account

Automatic Reinvestment allows automatic useof dividend and capital gains distributions andinterest to buy additional shares of the fund withoutpaying any commissions.



Figure 15.2: The Wisdom of AutomaticReinvestment



Switching Privileges within a MutualFund Family

Switching Privilege (or Exchange Privilege)permits mutual fund shareholders to easily swapshares on a dollar-for-dollar basis for shares inanother mutual fund within a mutual fund family.

Exchange Fee a small charge, typically $5 or$10 per transaction, on transfers from one fund toanother.

Mutual Fund Family when the samemanagement company operates a variety of mutualfunds, each with its own investment objectives.



Withdrawal Plans

Withdrawal Plans (or Systematic WithdrawalPlans) available to shareholders who want aperiodic income from their mutual fund investments.

You can take your funds out of a mutual fund usingone 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 Expenses

Management Fee annual assessment topay advisors who operate the mutual fund.

12b-1 Fee (or Distribution Fee) annualcharge deducted by a fund company fromfunds assets to pay for advertising,

marketing, distribution, and promotion costs.

Ongoing expenses that increases fund costs

Avoid funds with this charge (see prospectus)



Disclosure of Fees

Standardized Expense Table illustrates in an

identical manner the effects of a mutual fundsfees and other expenses (hypothetical scenario)

Expense Ratio the combined percentage (offund assets) charged annually for expenses

including management fees, 12b-1 fees, and otherexpenses of the mutual fund company.



Whats Best: Load or No-Load?Low-Fee or High-Fee?

Up-front load charges are costly to investorsin the short run (less than five years),

Annual 12b-1 charges are very costly over

the long run (increase expense ratio)

Over five-year periods, lower-cost fundsalways deliver better returns than those

offered by higher-cost funds. Funds with no 12b-1 fees

Index funds


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Managed Funds or Index Funds?

Managed Funds professional managers areconstantly evaluating and choosing securitiesusing a specific investment approach.

Index Fund a mutual fund that buys and holdsstocks or bonds that constitute a market index.

Managers do not evaluate and select individualsecurities, but rather buy and hold all the stocks in a

particular index.

Examples of market indexes?


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How to Evaluate Mutual Funds inWhich to Invest

Match your investment philosophy andfinancial goals to a mutual funds

objectives

Read prospectuses and annual reportsAnnual Report a published summary of

the financial activities of a mutual fund

company for the year.


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How to Evaluate Mutual Funds inWhich to Invest (Continued)

Locate sources of comparative performancedata:

The Financial Press (Examples?)

Specialized mutual fund investmentpublications (e.g., Morningstar Mutual Funds)

Magazines that rate mutual funds

Internet sources on mutual funds

www.ici.org

www.morningstar.org

Fi 15 3 B l i Ri k d


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Figure 15.3: Balancing Risk andReturns on Mutual Funds


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Interpret Comparative PerformanceInformation Over Time

Consider a funds volatility a securitysor mutual funds tendency to rise or fall inprice over a period of time.

Consider a funds long- and short-termperformance

Consider a funds size Consider a funds performance in up and

down markets


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Golden Rules of Investing in MutualFunds

1. Invest only in no-load mutual funds that havea low expense ratio and do not assess a12(b)1 fee.

2. When choosing mutual funds, always matchyour investment philosophy and financialgoals to a mutual funds objectives

3. When investing for long-term goals, definitelysign up for automatic reinvestment of yourmutual fund dividends.


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Golden Rules of Investing in MutualFunds (Continued)

4. If you have a defined contribution retirementplan available at work, sign up for payrollwithholding to automatically forward a portionof each paycheck to a mutual fund.

5. Invest most of your serious money such asto pay for a childs education and retirement in one or more low-fee diversified index funds.

6. Dont jump in and out of the mutual fundmarket; instead, keep it simple by investing in afew funds and leave your money alone.

chapter 15 investing through mutual fund

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