Transcript Nobody plans to fail....

Chapter 13
Investing in
Mutual Funds
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
Investing in Mutual Funds
Chapter Objectives
1. Explain the characteristics of mutual
fund investments.
2. Classify mutual funds by investment
objective.
3. Evaluate mutual funds.
4. Describe how and why mutual funds
are bought and sold.
13-2
Objective 1
Explain the Characteristics of Mutual
Fund Investments
• Mutual Fund = an investment vehicle
offered by investment companies to those
who wish to:
– Pool money
– Buy stocks, bonds, and other financial securities
– Have buy/sell decisions made by a fund
manager
• Many mutual funds chosen for inclusion in
retirement account investments
13-3
Investment Company
• Pools the money of many investors –
its shareholders – to invest in a variety
of securities
• Employs the fund manager who is
compensated for selecting securities
appropriate to the fund’s stated
objective
• “Financial Intermediary”
13-4
Why Investors Purchase
Mutual Funds
• Professional management
– Who is the fund’s manager?
– How has the fund performed
under the current managers?
• Diversification
– Investor’s funds are used to purchase a
variety of investments
– Risk reduction
13-5
Characteristics of Funds
• Closed-end funds
– Fixed number of shares
– Trade like shares of common stock
– Actively managed
• Exchange-traded Funds
– Invests in securities contained in a specific
securities index
• Open-end mutual funds
– Shares issued and redeemed on demand
– Actively managed
13-6
Closed-End Funds
• Fixed number of shares issued when the
fund is organized
• Shares traded on stock exchanges
•Trade price set by supply & demand
• Most sell at a discount relative to their
net asset value
• Discount is sometimes substantial
13-7
Exchange Traded Funds
• Invests to replicate the composition of a
specific securities index
– Performance mirrors index performance
• Low management fees
• Trade on exchanges throughout the day
like stock
– Prices determined by supply and demand
• Can be sold short and traded with limit
orders
13-8
Net Asset Value
• Net asset value (NAV):
– Assets under Management (AUM)
• The current market value of the assets
held by the fund
– Net Assets = AUM - Liabilities
Net Assets
NAV 
SharesOutstanding
• NAV calculated at the close of
trading
13-9
Open-End Funds
• Open-end funds ≈ 90% of all funds
– Shares issued and redeemed by the
investment company at the request of
investors
– Investors free to buy and sell shares at the
net asset value (NAV)
13-10
Costs: Load Funds vs. No-Load Funds
• Load Fund
– Sometimes called an “A” fund
– Commission (sales charge) up to 8.5%
• Average = 3 to 5%
– Paid every time shares purchased
– Purchased through brokerage firms or
registered representatives
• Salespeople prepared to explain the fund and
help determine if it meets the investor’s
financial goals
13-11
Costs: Load Funds vs. No-Load Funds
• No-Load Fund
– No up-front sales charge
– No salespeople
– Investor deals directly with the investment
company via 800 numbers or web sites, or
from discount brokers
13-12
Costs: Load Funds vs. No-Load Funds
• Contingent deferred sales charge (CDSC)
– “Back-end load”
– “B” fund
– “Redemption fee”
– Charged upon withdrawal of funds (1-5%)
– Generally decreases on a sliding scale
depending on the number of years shares
are held
13-13
Costs: Management Fees and
Other Charges
• Management fee
– Charged yearly (.25%-1.5% average) based
on a percentage of AUM
• 12b-1 fees
– Annual fee to defray advertising and
marketing costs
– Cannot exceed 1% of AUM per year
• Expense ratio
– Total expenses associated with the
management fees and operating costs of the
fund
13-14
Typical Mutual Fund Fees
13-15
Objective 2
Classify Mutual Funds by Investment
Objective
Long-term
Funds
Stock Funds
Bonds Funds
Other Funds
13-16
Stock Funds
Long-term
Funds
Stock Funds
Bonds Funds
Other Funds
Aggressive Growth
Growth
Price growth vs.
Dividend Income
Equity income
Small-cap
Mid-cap
Company Size
Large-cap
Global
Regional
% U.S. vs.
International
International
Index funds
Match index holdings
Sector funds
Economic Sectors
Socially responsible
Invest in socially
responsible firms
13-17
Bond Funds
Long-term Funds
Stock Funds
Bonds Funds
Other Funds
High-yield
Intermediate
Corporate bonds
Intermediate U.S.
Gov't bonds
Long-term
corporate bonds
Long-term U.S.
gov't bonds
Municipal bonds
Short-term
corporate bonds
Short-term
U.S.gov't bonds
13-18
Other Funds
Long-term
Funds
Stock Funds
Bonds Funds
Other Funds
Asset Allocation Funds
Balanced Funds
Fund of Funds
Lifecycle Funds
Money Market Funds
13-19
A Family of Funds
• One investment company manages a
group of mutual funds
– Each fund has a different financial
objective
– Exchange privileges allow movement from
one fund to another within the family with
low or no charge
• Fidelity Investments
– http://personal.fidelity.com/products/fu
nds/mutual_funds_overview.shtml.cvsr
13-20
Objective 3
Evaluate Mutual Funds
Managed Funds vs. Index Funds
• Managed fund  a fund manager
makes all decisions regarding what
securities are included in the fund’s
portfolio
• Index fund  securities held by the
fund replicate those contained in a
specific index like the S&P 500
13-21
Sources of Fund Information
1. Internet websites provide current values
–
http://finance.yahoo.com
–
www.businessweek.com
–
www.morningstar.com
–
www.smartmoney.com
2. Check fund companies’ Internet sites
–
www.troweprice.com
–
www.vanguard.com
13-22
Sources of Fund Information
3. Professional Advisory Services
–
–
–
–
–
Lipper Analytical Services
Morningstar, Inc.
Value Line
Mutual fund newsletters
Available in libraries and from
brokerage firms
13-23
Mutual Fund Prospectus
–
–
–
–
–
–
–
–
–
–
Fund objective(s)
Statement describing the risk factors
Description of the fund’s past performance
Statement describing the type of investments in the
fund’s portfolio
Information about dividends, distributions and taxes
Information about the fund’s management
Information about limitations or requirements for the
fund
Procedure to buy or sell shares
Services provided to investors
Turnover ratio of the fund’s investments
13-24
Other Sources of Fund Information
• Mutual fund annual report
– Performance, investments, assets & liabilities
• Financial Publications
– Business Week, Forbes, Kiplinger's Personal
Finance and Money
– Business Week’s mutual fund survey
includes:
• Fund’s overall rating compared to all other funds,
and to funds in the same category
• Fund size, sales charge and expense ratio
• Historical returns for the past ten years
13-25
Objective 4
Describe How and Why Mutual Funds are
Bought and Sold
The Mechanics of a Mutual Fund
Transaction
• Open an account:
– $250 to $3,000 and up depending on the fund
family and the fund
13-26
Return on Investment
3 Ways to Make Money on Mutual Funds
Income Dividends
– Earnings paid from dividend and interest income
– Taxed as ordinary income
Capital Gains Distribution
– Distributions when the fund buys and sells
securities
– Taxed as long-term gains
Capital Gains (or Losses)
– Capital gains (or losses) when you sell shares at a
price different than price you originally paid
– Taxed as short- or long-term gains
13-27
Purchase Options
Fund Type
Purchase From
Closed End
Stock exchange or Over-the-counter
market
Exchange Traded
Open End
*
No Load
Fund Management Co.
Load
Authorized Agent
Fund
Supermarket*
* Investor may deal with one company, get one statement,
yet have a choice of a wide variety of funds
13-28
Purchasing Open-End Fund Shares
– Regular account transactions
• Easiest
• Simply buy shares in amount and when desired
– Voluntary savings plans
• Allows for smaller than usual purchases on a
recurring basis
– Contractual savings plans
• Require regular purchases over a specified period
– Reinvestment plans
• Automatically reinvests dividends and capital gains
in the fund
13-29
Withdrawal Options
•
Closed-end funds & exchange-traded
funds
– Traded on stock exchanges and in the over
the counter market
– Sold like common stock shares
•
Open-end fund
– Shares sold to the fund sponsoring
company
13-30
Mutual Fund Withdrawal Options
1. Withdraw a fixed dollar amount each period
until account exhausted
2. Liquidate or “sell off’ a certain number of
shares each period
3. Withdraw a fixed percentage of asset growth;
principal untouched
4. Withdraw all income dividends and capital
gains distribution; principal untouched
13-31
END OF CHAPTER 13
13-32
Additional Video
Mutual Fund Awards BusinessWeek and S&P’s Best Fund Picks
(Instructors see the notes section for directions.)
SYNOPIS: Helpful information about how BusinessWeek and
Standard & Poor’s evaluate mutual funds is provided in this video.
In addition, specific funds that are highly rated in the BusinessWeek
survey are recommended.
1. Explain why investors still need to evaluate mutual funds when
there is a professional manager or team of managers that choose
the investments for a mutual fund.
2. What factors did BusinessWeek and Standard & Poor’s use to
evaluate mutual funds? Would these same factors help you
evaluate a mutual fund for your investment portfolio?
3. Specific small-cap, technology, and growth funds were described in
this video. How would you research one of these funds to
determine if the fund could help you obtain your investment goals?
13-33