Mutual FundsFinancial Literacy

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What We Will Cover

• What is a Mutual Fund?• Advantages and Disadvantage of

Mutual Funds• Costs of Mutual Funds• Types of Mutual Funds• ETFs• Buying a Mutual Fund

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What is a Mutual Fund?

• Investors pool their money• A fund manager buys a variety of

stocks• Each investor owns a share of the fund

(the total of all the stocks in the fund)• When the fund increases in value, the

investor makes money

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How Mutual Funds Work

Many investors (hundreds or thousands) put their money into the mutual fund pool.A professional manager will pick the stocks and bonds to buy

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Net Asset Value

• Mutual funds do not change price during the trading day

• The price you buy and sell for is called net asset value (NAV) rather than stock price• It is updated only once a day, at the end of

the trading day• Formula for NAV is: Total value of

securities minus debts divided by number of shares

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Open-Ended Funds

• This type of fund may issue as many shares as it wishes, and anyone can invest

• 95% of funds are open-ended

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Closed-End Funds

• Closed-end funds can issue a limited number of shares

• Investors buy and sell shares among themselves

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Advantages of Mutual Funds

• Diversification• You purchase a small amount of many

stocks without having to physically buy each stock

• Professional Management• Fund managers are professionals with

access to better information than the average investor

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Advantages of Mutual Funds

• Minimal transaction costs• Individual investors save on brokerage

fees compared to individual stock purchases. In a retirement account

there is no brokerage fee• Liquidity

• Easy to buy and sell• Flexibility

• There are over 8000 funds to choose from, allowing you to invest in an area you want

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Disadvantages of Mutual Funds

• Lower-than-market performance• On average, mutual funds underperform the market

• Costs• Always charge an annual fee• May also charge a sales fee• These fees will eat away your

profits

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Disadvantages of Mutual Funds

• Risk• Depending on the segment of the market

the mutual fund invests, it may do very well or very poorly

• Systemic Risk• A market crash will have a negative effect

on your fund

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Costs of Mutual Funds

• “Load” funds charge a commission to buy or sell the funds• Usually 4-8% of the investment

• “Front-end load” means you pay a commission when you buy

• “Back-end load” means you pay a commission when you sell the fund

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Costs of Mutual Funds

• “No-load” funds mean you don’t pay a sales commission

• Some funds will charge a fee if you sell within a specific period of time, such as 90 days

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Costs of Mutual Funds

• Owners of mutual funds pay an annual expense• Known as the expense ratio• Typically it is .25 to 2 percent of the

investment value• Try to buy a fund with the lowest

expense ratio (annual fee) possible• Expenses can eat up all or most of your

profits, especially if the fund isn’t performing well

Costs of Mutual Funds

• Annual fee• You will have to pay an annual fee even if

your mutual fund did not make money that year

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Costs of Mutual Funds

• Taxes• Generally you will have to pay taxes on

the profits every year, except in a retirement account

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Costs of Mutual Funds

• 12b-1 fee• These are marketing expenses passed on

to the investor• They do not benefit the investor at all

• Try to find funds that have minimum or no 12b-1 fees• They will eat into your profits and do not

provide any benefit to the investor

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Types of Mutual Funds

• Stock funds• Most popular types of

funds• These funds invest

mostly in stocks, but may also invest in cash, bonds, and money market funds

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Types of Stock Funds

• Aggressive Growth Funds• The fund buys stocks that will (hopefully)

increase dramatically in price• Very volatile

• Small-Company Growth Funds• Investments are limited to small

companies• Volatile

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Types of Stock Funds

• Income Funds• Concentrate more on strong companies

paying dividends (the dividends are the “income” in income funds)

• Less risky than aggressive growth funds• Growth-and-Income Funds

• Concentrate on stocks providing dividends plus the potential for growth

• Less volatile

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Types of Stock Funds

• Sector Funds• Specializes in stocks from a specific

industry• Computer, financial services, biotech precious

metals, etc.• International

• Invests mostly in stocks outside the U.S.

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Types of Mutual Funds

• Balanced funds• Holds both stocks and bonds

• Asset Allocation• Balanced funds with market timing

Types of Mutual Funds

• Life Cycle Funds (relatively new)• Attempt to tailor holdings to the investor’s

age and risk tolerance• The fund is managed based on how close

you are to retirement

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Types of Mutual Funds

• Bond funds• Invest in bonds rather than stocks• Emphasize income over growth

• Types of bond funds (remember than when you buy a bond, you are actually lending money to the company or the government)• U.S. Government bonds• Municipal bonds (bonds issued by city or

state)• Corporate bonds (from a company)

Index Funds

• Index funds will directly mirror an index:• DOW (DIA and others)• S & P 500 (SPX and others)• Nasdaq (QQQ and others)

• Inverse index funds will directly mirror the opposite of the market

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ETFs (Exchange Traded Funds)

• ETF’s are available for any segment of the market, just as mutual funds are

• Lower expenses than mutual funds

ETF’s

• There are also inverse ETF’s which will make you money when the market goes down• However, you will lose money when the

market goes up

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Buying a Mutual Fund

• Determine your goals• What are you investing for?

• Retirement• Education• Income• Growth

• Meeting your objectives• Make sure the fund meets your goals

(above)

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Evaluate the Fund

• www.morningstar.com identifies funds by investment strategy and management style

• Look closely at past performance and expenses

• Compare funds in the same category; do not compare a growth fund to an international fund, for example

• Look for “star” ratings (4-star and 5-star ratings)

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Buying a Mutual Fund

• You can purchase through your company’s 401(k) website

• You can purchase directly from the mutual fund company

• You can purchase from your broker• You can purchase through your bank• Many funds will let you invest with as

little as $100 in a retirement account