Transcript ALFS Module - II 5/23/2016 1

ALFS Module - II
5/23/2016
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Module Objectives
Review of Stocks and Bonds
 Mutual Funds
 Prepare for Module III
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Mutual Funds
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What are they?? They are companies that pool money of many
individuals and institutions and invests it on their behalf. There are
mutual funds that specialize in stocks, bonds, money markets, etc.
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Who owns them? One out of every three households in the US
owns some mutual fund shares.
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Seniors are living longer- By the year 2030, the number of people
age 65 and over is projected to more than double, and those 85 and
over to almost triple.
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Social Security Future- By 2020, there may only be two workers
per retiree, causing a strain on the system.
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Mutual Funds
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Competition for Investors’ Funds-
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Mutual Funds- Some are sold through a sales force, but many are sold
directly to the public. Many are sold without a sales charge (no-load),
and appeal to those who are willing to do their own research.
Insurance Companies- Many agents have started to sell mutual funds
since the 1980’s.
Brokerage Houses- Brokers are not likely to sell their clients life
insurance, but are quite likely to recommend annuities and will put
their clients in mutual funds.
Banks- they have just recently started to promote the sale of mutual
funds to their customers. As interest rates have dropped, many
investors have moved their money elsewhere into funds.They currently
manage 11% of all mutual fund assets.
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Mutual Funds
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How Mutual Funds Work
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Stocks-Equity- Stocks represent a share of ownership, or equity, in a
corporation. As part owners, stockholders can share in the profits of
the corporation. Investors can make money in two ways:
– when they receive dividends from the company
– when they sell stocks that have increased in value
Dividends- many companies pay a dividend each quarter-so much for
each share held. Dividends are not automatic.
Capital Growth- Investors usually buy their stocks from other investors
through brokers, not directly from the corporation. Once the
corporation has received the proceeds from the original issue, the stock
enters the equivalent of the “used car market”-the stock market.
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Mutual Funds
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Bonds-Debt- A bond is a certificate of debt issued by a corporation or
some form of government organization. It indicates that the investor
has loaned the issuer money, which the issuer promises to repay in full
at a specified date, anywhere from 1 to 30 years in the future.Investors
in bonds make money one of two ways:
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when they receive interest paid by the issuer
when they sell bonds that have increased in value
Interest- the issuer sets the interest rate on a bond issue. It has to be high
enough to attract investors to buy the bond.
Market Value- The par or face value of a bond represents the amount of
money that must be repaid to the investor, so it should always be worth its
face amount at maturity. However, in the years before it matures, a bond is
worth whatever someone is willing to pay for it.There is a secondary
market for bonds, just like stocks. Interest rates fluctuate, and there is an
inverse relationship between prevailing interest rates and the market price
of bonds. In general, bond values go up when interest rates drop and visaversa.
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Mutual Funds
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Tax Exempt Issues- there is a class of bonds that offer investors a tax shelter
called municipals, or muni’s.
Investment Companies- their primary business is investing in
securities, stocks, bonds,and the money market. By law, investment
companies are divided into 3 types:
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unit investment trusts
face amount certificate companies
management companies which include open and closed end funds
Unit investment trusts- a UIT as it is called, is an investment company
organized under a trust indenture. A UIT invests in a fixed
portfolio.Investors in a UIT are technically buying shares of beneficial
interest.
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Mutual Funds
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Closed-End Fundsthese are managed
companies, just like
mutual funds, and their
primary business is
investing in securities.
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Mutual Funds-Types of Investment Companies
Portfolio
Management
Life Span
Buying Shares
Selling Shares
Price
Sales Charge
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Unit Trusts
Closed-End
Funds
Mutual Funds
Professionally
selected, not
managed
Limited;
specified
liquidation date
Fixed number
available
Professionally
selected and
managed
Continuous Life
Professionally
selected and
managed
Continuous Life
Specific number
of shares issued
Continuous
offering of new
shares
Very limited
Stock exchanges Fund must
or over the
redeem at net
counter
asset value
Fixed, often
Set by market
Net asset value
$1,000
plus sales
charges
Front-end loaded Brokerage
Possible frontcommissions
end charges
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Mutual Funds
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How a Mutual Fund Works
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1. Individual investors invest in the fund and receive shares in
return.
2. The fund invests this pool of money in a an investment portfolio.
3. The fund’s return on investment, is distributed as dividends,
subject to tax.
4. At any given time, the investors may redeem shares and the
mutual fund must pay the investors the current value of the shares.
5. The investor must pay tax on all earnings and capital gains.
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Mutual Funds
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Mutual Fund Structure
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Shareholders- actually own the fund, but depend on others to run it
The board of directors- the board has the authority to appoint
officers.At least 40% of the board must be outside directors, with
no direct connection to the fund.
Investment Management- Typically the board will have a contract
with an investment management company, which supervises the
fund’s portfolio and decides when to buy or sell.
The Underwriter or Distributor- This person is usually the sales
organization. It prepares the sales literature for the fund.
The Custodian--The fund contracts with a firm, usually a bank, to
act as the custodian. They safeguard the physical assets, pays for
the securities,receives pay-out dividends, and serves as registrar.
Transfer Agent- They are responsible for issuing new shares,
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canceling shares, and sending dividends.
Mutual Funds
 Review
on page
17, Unit 2
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Mutual Funds
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Why Buy Mutual Funds?
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Professional Management
Diversification
Ease of Purchase
Families of Funds
Liquidity
Convenience Features
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Systematic Withdrawal Plans
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Fixed Dollar
Fixed Shares
Fixed Percentage
Fixed Time
Automatic Reinvestment
Record Keeping
Telephone Services
Checkwriting Privileges
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Mutual Funds
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Suitability: Matching Investor Needs
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Investment Objectives and Limitations- There are two general
categories of investment objectives:
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Income- Investors may have this as their sole objective. These will
be qualified by 2 additional secondary objectives:
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Income
Capital Growth
income with safety of principal
income with possibilities for growth
Growth- A growth objective entails some risk.
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Mutual Funds
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Financial Status of Investors- To a great extent, the
investor’s finances govern their investment program. Two
useful tools to determine their status are:
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Kinds of Risk
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Personal Net Worth- a balance sheet of assets and liabilities
Personal Income Statement- Determines discretionary income after
all expenses are accounted for.
1. Business or financial risk
2. Market Risk
3. Interest Rate Risk
4. Purchasing Power Risk
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Mutual Funds
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Balancing Risks and Rewards
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Yield on Investments- The basic formula for computing the current
yield is:
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Mutual Fund Yields and Total Return
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Yield= Annualized Dividend or Interest
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Current Price
Example- The current yield on a stock selling at $25, paying an
annual dividend of $2.50, would be .1 or 10%
Money Market Funds- These report their current yield based on
earnings over the past 7 days. The effective yield is calculated on an
annual basis, assuming reinvestment over the course of that year.
Total Return- The SEC requires all funds to report total return for
the past 1, 5, and 10 years.It will include capital appreciation as
well as dividend yields.
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Mutual Funds
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Balancing Risks and Rewards
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Equivalent Yields on Tax-exempt Bonds- Because Municipal bonds
are exempt from federal taxes, they can pay a lower rate of interest,
but still provide the same effective yield as taxable bonds paying a
higher interest rate. Tax-exempt bonds effective yield is calculated
as follows:
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Equivalent Taxable Yield=
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Example=
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The Balance
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Municipal Bond Yield
100%-Investor’s Federal Tax Rate
________6%______
(100-28%)=72 = .83 or 8.3%
The balance between risk and reward is the reason for so many
different mutual funds
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Mutual Funds
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Types of Mutual Funds- Funds can be grouped under the
two basic objectives of all investments. They will be either
growth or income funds, or a combination of the two.
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Income Funds
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Money Market Funds
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Taxable Bond Funds
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Taxable- Invest in short-term highly liquid debt obligations
Tax-Exempt- invest in municipal securities with short maturities
One-state Tax-exempt- Concentrate on issues from one state
US Treasury-Invest in Treasury bonds and debt obligations of the US
government
US Government- invest in federally-guaranteed mortgage securities
Long-term Bonds- Combination of corporate and government bonds with
long maturities (15-30 years).
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Mutual Funds
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Income Funds
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Taxable Bond Funds
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Municipal Bond Funds
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Short-Term Bonds- invest in bonds with <5 years till maturity
Work Income- invest in debt securities of companies around the
world.
High-Yield Corporate-sometimes called “junk bond” funds
High-grade tax exempt- invest in long-term bonds issued by state and
municipal governments that are rated A or better.
Short-term tax-exempt-invest in municipals that are close to maturity.
One-State Tax-Exempt-Restrict investments to municipals of one state
to avoid federal and state taxes.
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Mutual Funds
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Income Funds
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Balanced and Mixed Funds
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Balanced-fund generally spread across bonds, common and preferred
stocks. At least 25% must be invested in fixed-income securities.
Asset Allocation- Also called flexible portfolio, they give the manager
discretion to adjust percentages broadly.
Equity Income- these funds concentrate on investing in stock of
corporations with a record of making consistent dividend payments.
Growth and Income- Investment in the common stock of wellestablished, blue-chip corporations.
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Mutual Funds
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Growth or Equity Funds
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Growth- means capital appreciation as opposed to income from
dividends.Investment would mainly be in well-established
companies.
Global Equity- investments in equity securities of companies
throughout the world.
Small Company-also called small cap funds. Invest in small,
growing companies.
Social Awareness- invest in companies known for the responsible
social or environmental issues.
International- 2/3 or more are in securities outside of US
Sector-Geared towards one specialty or industry
Aggressive Growth- Also called maximum capital gain.
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Mutual Funds
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Comparisons of Mutual Funds
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Sources of Information- some of the factual information can be
found in:
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Basis of Comparison- there are 3 factors that form the basis of
comparison of mutual funds
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the prospectus
the Statement of Additional Information
shareholders report
the fund’s sales literature
1. Performance2. Risk
3. Cost
4. Other factors
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Mutual Funds
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Investing in Mutual Fund Shares
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Distribution- are distributed one of two ways:
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Sales Charges
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Directly from the fund-normally “no load”. All money market funds
are no load.Typically sold through direct mail or telephone.
Sales Representatives-51% of the industry’s volume came in this way
Front-End Loads- many funds include a sales charge as part of the
share price.This load may be as much as 8.5% of the selling price.
Most are between 3.5% to 5%. The sales charge is called a concession
Contingent Deferred Sales charges or Back-End loads- a deferred
sales charge is collected when shares are redeemed.
Redemption Fees-Some charge this fee that might be 1 to 2% of the
amount redeemed.
12b-1 Distribution Fees-some charge this fee to cover distribution and
sales-related expenses.Named by SEC rule.It is charged against the
fund itself.
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Mutual Funds
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Net Asset Value (NAV)
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How the NAV is calculated- at the end of each business day, the
mutual fund adds up the market value of all securities in its
portfolio, subtracts its expenses, and divides this total by the
number of shares outstanding. All shares redeemed that day must
be redeemed at that NAV. All shares sold must be sold at NAV, plus
any sales charge. This is called the public offering price. These are
the BUY and SELL prices that are reported each day in the
financial pages.For a no-load, the NAV is the public offering price.
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Mutual Funds
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Ex-Dividend
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Forms of Share Ownership
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A fund’s NAV will drip whenever the fund distributes a dividend
or capital gain. The NAV per share will drop by the amount of the
distribution, since the distribution reduces the total assets.
Individual RegistrationJoint Tenants- When 2 or more people own the securities with
survivorship rights
Tenants in Common- 2 or more people own the securities, but they
don’t have to have equal interests. If one dies, the interest goes to
that parties estate rather than the other interest’s.
Trust Accounts- Held by a trustee for the beneficiary
Uniform Transfers/gifts to Minors Act-the minor owns the shares,
but a custodian has the right to manage the gift until minor’s
adulthood.
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Mutual Funds
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Mutual funds and Retirement Plans
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IRA’s- they allow workers under age 70 1/2 who earn income, to
put $2,000 away each year into a tax-sheltered account. There is a
10% penalty if the money is taken out before 59 1/2, in addition to
the taxes.There are some exceptions to this, however.
Lump-Sum Distributions and rollovers- 2 options when an
employee leaves a company and has a retirement fund:
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1. Put it in another retirement plan, like an IRA. The money must be
reinvested within 60 days. They could use:
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A rollover IRA
another qualified plan
IRA
2. Take the distribution-Pay the taxes and 10% penalty if withdrawn
before 59 1/2.
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Mutual Funds
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Simplified Employee Pensions- (SEP)
Keogh Plans for Self Employed
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401K Plans
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Contributions are tax-deductible and earnings are tax sheltered.
Some employers will match contributions. Typically have at least 3
options for the employee to choose.Mutual funds are very popular
in these plans.
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Mutual Funds
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Taxation of Mutual Fund Investments
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Regulated Investment Companies
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Distributions to Shareholders- Mutual funds report their dividend
distributions as coming from 1 of 3 sources:
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According to the IRS tax code, mutual funds must distribute at least
90% of their taxable income to shareholders each year. Generally,
they distribute close to 100%. Mutual fund earnings are taxed when
they are received.
Tax-Exempt Income-income from state and muni bonds are exempt
from federal taxes.
Ordinary Income
Capital gains
Tax-Exempt Interest
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Mutual Funds
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Distributions to Shareholders
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Income Tax- Shareholders must report all dividends received
Capital Gains Taxes- 2 ways
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Redeeming fund shares at higher price than paid for
Capital Gains distribution from the fund
Redemptions
 Cost Basis-When investors sell part of their shares, they must
know their cost to establish the capital loss or gain. The
difference between the cost and the price at time of sale or
exchange is the amount of the gain or loss. The cost basis
includes:
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the actual cost including sales load
the price of any additional shares they received when dividends are
reinvested
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Mutual Funds
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Redemptions
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Identifying Shares-3 ways to identify the cost of the shares being
redeemed:
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1. Designated Shares-this method can produce lowest amount of tax.
2. FIFO- First in First Out- If the investor can’t identify the specific
shares redeemed, the IRS says to assume the shares sold were those
purchased first.
3. Average basis-When all else fails, they should be calculated by the
average cost per share.
Offsetting Gains and Losses-Once the cost basis and holding
period are established, the investor should figure the long-term loss
or gain and any short-term loss or gain for each sale of fund shares
during the tax year.
Wash Sale-is a sale and repurchase of securities without any real
economic change.
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Mutual Funds
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Keeping Records- it is imperative for the investor to keep
good records to avoid overpaying of taxes.
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Form 1099-shareholders are responsible for reporting to the IRS
and the proper state tax agencies all dividend and capital gains
distributions they receive from the fund.Investors get a 1099 form
notifying them as to the amount they must report as income, capital
gains, or a one time return of capital if any.
Other Tax Deductions-Investors can claim miscellaneous
deductions if they exceed 2% of AGI.
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Mutual Funds
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Prospecting for and Selling Mutual Funds
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Life Insurance and Mutual Funds-Many agents are finding success
selling both.
The Target Market-Excellent candidates include:
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Precautions for selling funds
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Clients
Small business owners
Professionals
Business executives
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Registration-Must pass Series 6 or 7 exam
Prospectus
Sales literature
Statements made to prospective investors
suitability
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Mutual Funds
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Approaching the Prospect
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Pre-approach letter
Telephoning for the appointment
Sales Interview- The steps are as follows:
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The Approach
Fact-finding
The presentation
Handling Objections
Closing the Sale
Referred Leads- best source
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Mutual Funds
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Review Page 77, Unit
8
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