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mutual unds

investing

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The mission o The USAA

Educational Foundation is

to help consumers make

inormed decisions by providinginormation on nancial

management, saety concerns

and signicant lie events.

our mission

This publication is not medical, saety, legal, tax or investment advice. It is only a general overview o the subject presented. The USAA EducationalFoundation, a nonproft organization, does not provide proessional services or fnancial, accounting or legal matters. Consult your tax and legal advisersregarding your specifc situation. Inormation in this publication could be time sensitive and may be outdated. The Foundation does not endorse or promoteany commercial supplier, product or service.

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Wh a m ? 2An introduction

typ o m 3Exploring the large and varied und universe

s Ch, a oh exp 5Understanding und expenses, sales chargesand taxes

B a P 7Balancing risk and reward and selectingindividual unds

taBle o Contents

March 2010

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2

A mutual und pools the money o many investors to invest in a variety

o stocks, bonds or other securities. Each und has its own investment

objective, with some unds investing more aggressively and others in-

vesting more conservatively.

When you invest money in a mutual und, you receive shares o the

und. Each share represents an interest in the unds portolio and the

value o your mutual und shares will rise and all depending upon theperormance o the securities in the portolio.

A mutual und is managed by one or more proessional managers. The

unds investment portolio is designed to achieve specic objectives.

Portolios typically contain 50 to 200 dierent stocks, bonds and other

securities. The composition o each portolio varies according to the

unds investment objectives and the level o risk permitted.

While the returns o mutual unds are not guaranteed, they do oermany advantages, especially or the inexperienced investor. Mutual

unds allow you to invest in a variety o industries and investments,

which may be dicult to do individually without having large amounts

o money to invest.

The purpose o this publication is to help you understand how mutual

unds work and provide you the principles or creating a well-balanced

portolio.

WHat are mutual unds?

a mutual und

Pools tHe moneY

o manY inves-

tors to invest

in a varietY o

stoCKs, Bondsor otHer

seCurities.

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3tYPes o mutual unds

There are currently over 10,000 mutual unds available with new unds

being introduced each year. Beore you begin investing in a mutual

und, make sure the investment strategy o the und is in line with your

nancial goals and risk tolerance.

mj CMost mutual unds all into one o our main categories money mar-

ket unds, bond unds, stock unds and asset allocation unds. Eachtype has dierent eatures and dierent risks and rewards. Generally,

the higher the potential return, the higher the risk o loss.

my k invest in very low-risk securities and are designed

to provide a place or holding cash or cash equivalents. There are two

types o money market unds: taxable and tax-ree. The latter invest

in municipal securities whose interest is generally exempt rom ederal

income tax.

B are also known as debt unds. When you purchase bonds, you are essentially making

a loan to the bonds issuer. Bonds are issued by companies and ederal, state and local govern-

ments.

sck are also known as equity unds. When a und manager purchases stock, the und

becomes an owner o the company that issued the stock.

a c include a diversied portolio o investments which may include stocks,

bonds, money market or other securities. Asset allocation unds diversiy your investments to help

capitalize on changes in market conditions and to help manage risk.

a a d o m Mutual unds have become one o the most popular orms o investing in the United States, with

over $10.9 trillion in assets as o November 2009, according to the Investment Company Institute

(ICI).

Like any investment, there are advantages and disadvantages you should consider beore investing.

Following is a list o mutual und eatures and some o the advantages and disadvantages o in-

vesting in mutual unds.

or more

inormation

The USAA Educational

Foundation publication,

Stocks And Bonds,

oers more inorma-

tion. See Resourceson the inside back

cover o this publication

to order a ree copy.

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4

eatures advantages disadvantages

dfc You can invest in a variety o industries

and categories o stocks, bonds and other

securities reducing investment risk. With

a broad investment base, total returns are

not as threatened by a ew unsatisactory

perormers.

Because mutual unds have hold-

ings in many companies, high

returns rom several investments

may not make much dierence in

your overall return. It is possible to

over-diversiy your investments.

lqy You can generally redeem or sell your

shares at any time at their current net

asset value.

When you sell your shares, you may

have a gain that is taxable or ederal

income tax purposes or a loss o

principal. Losses may be deductible

or ederal income tax purposes.

xby Mutual und companies oer a variety o

mutual unds with dierent nancial ob-

jectives managed by one company. You

can reallocate investments among those

unds as your goals and objectives change.

Movement o your monies between

mutual unds may result in a taxable

gain or ederal income tax purposes

or a loss o principal. Losses may

be deductible or ederal income taxpurposes.

Cc Most unds allow you to invest automa-

tically with an allotment or automatic

withdrawal rom your checking account

(also known as dollar-cost averaging). By

making xed, regular investments into a

mutual und, regardless o share price,

you may lessen your risk o putting a large

amount o money in a single investment at

the wrong time. Generally, you can buy orsell shares by phone, mail or online.

Such automatic allotment or with-

drawal plans do not assure a prot

and do not protect against losses in

declining markets.

P

m

Mutual funds are managed by professionals

who research and evaluate the investment

potential o hundreds o dierent compa-

nies and agencies. Individual investors

usually cannot get the same level o in-

vestment advice without a large portolio.

The investor cannot directly select

the underlying und investments

and generally cannot control the

amount o capital gains triggered

by the und. Mutual unds are not

always tax ecient.

r The industry is regulated by the Securities

and Exchange Commission (SEC) thatimposes requirements designed to protect

investors rom abuse.

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5sales CHarges, ees and otHer eXPenses

There are various types o expenses associated with purchasing and owning shares o mutual

unds. We begin with shareholders direct costs and then review the expense ratio, which is the one

expense common to all unds.

shh Cs ch. Many mutual unds, called , impose a sales charge to buy shares o the

und. Sales charges, also known as sales load or commission, compensate stockbrokers and others

who sell unds to investors. n- , purchased rom an investment management companyor through a brokerage account, do not charge sales loads.

tc . Some unds charge their shareholders a p when they sell or re-

deem shares. Redemption ees are typically paid directly to the mutual und and are designed to

cover the costs associated with the redemption itsel. Some unds also impose an xch

when a shareholder transers rom one und to another und within the same amily o unds.

Some unds charge an annual cc , typically a xed amount deducted rom the sharehold-

ers account. Shareholders are oten charged or accounts below the specied minimum balance.

op expm . These ees are paid to the investment adviser or management o the invest-

ment portolio. Management ees are paid out o the und assets. The shareholder service ee,

reerred to as the 12b-1 , gets its name rom the SEC rule that authorizes them. This ee helps

cover marketing and administrative costs.

exp rThe expense ratio refects the cost o running the mutual und, including the ollowing:

Salaries or portolio managers, analysts and service representatives.

The cost o printing shareholder reports.

Other administrative costs, including an allowance or some und company prot.

Rather than being deducted rom your individual account, these expenses are taken rom the

assets o the entire mutual und each day and are refected in the unds cost per share.

Expense ratios vary widely. Some types o unds are, by their nature, more costly to run than

others. For example, the ollowing relationships are generally true.

Stock unds are more expensive than bond unds.

International stock unds are more expensive than unds that ocus on U.S. stocks.

Actively managed unds are more expensive than index unds.

Funds with smaller levels of invested assets are more expensive than those with larger sums.

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tx a m In addition to costs imposed by mutual unds themselves, ederal, state and local taxes are

another important expense that should be considered when making investment decisions.

Unless you own your shares inside a tax-advantaged account, such as an Individual Retirement Ac-

count (IRA), Coverdell Education Savings Account or an employer-provided 401(k) plan, you may

be subject to ederal income tax on earnings you receive rom a mutual und. Dividend and capital

gain distributions are taxable, as are any capital gains you realize when you redeem shares.

As you select mutual unds or your portolio, realize some are less tax-ecient than others. Funds

with a high turnover rate tend to generate more capital gain distributions than those that hold

securities or longer periods o time. Likewise, high-yield bond unds generate a large amount o

taxable income. You may benet rom consulting a nancial planning proessional or tax account-

ant when deciding which unds to purchase within tax-advantaged accounts and which to purchase

in taxable accounts.

You should also be conscious o how your own decisions aect your taxes. Those who rapidly buyand sell mutual unds may generate many capital gains and losses, potentially raising their taxes

and certainly complicating their tax returns.

Many mutual unds are designed to minimize the tax burden o their investors. For example, some

invest in cp b which are issued by state and local governments to nance schools,

roads, hospitals or stadiums. Called munis or short, a key attraction o municipal bonds is their

tax treatment. In general, interest rom municipal bonds is exempt not only rom ederal income

tax but also rom state and local income tax in the states and cities where they are issued. This

tax treatment is passed through to municipal bond und investors.

do not BuY a distriBution

Beore investing in a mutual und, research its schedule or dividend and capital gains distributions.

You will nd most mutual unds make these distributions in December. I you purchase a und just

beore it makes a distribution, you will be liable or taxes even though you may not have proted

rom any gain.

exp: You invest $10,000 in a mutual und, buying 1,000 shares at $10 per share. The next

day, the und issues a $1 per share capital gain distribution, refecting gains realized when the

portolio manager sold some securities earlier that year. You will have to report the $1,000 capital

gain distribution on your taxes, even though you have yet to prot rom the investment.

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7Building a und Portolio

Beore investing in mutual unds, careully consider your goals, how long you have to achieve them

and your level o comort with investment fuctuations. This will help you create the ramework or

a und portolio that meets your needs.

rk a rwPerhaps one o the most important considerations in creating a portolio is the amount o risk you

wish to take. Generally, the more risk an investor takes with a given investment, the greater the

return they should hope to receive.

Generally, stocks are considered to be riskier than bonds because their value tends to fuctuate

more. To compensate or the greater risk, investments in stocks have historically provided a

greater return.

Every investment has some element o risk. The relatively low returns associated with a money

market und, or example, leave the investor exposed to purchasing power risk. This is the risk that

the buying power o your assets will decline over time i your investment returns do not equal or

exceed the rate o infation.

Deciding the mix o stocks, bonds and cash that is right or you depends on a variety o actors.

Readiness or emergencies. Beore investing in longer-term assets, you should save 3 to

6 months o basic living expenses in a cash account so you are ready or unexpected ex-

penses such as a vehicle repair or a job layo.

Timing o your goal. The sooner you will need to use your money, the less you can generally

aord to see it fuctuate in value.

Your eelings about volatility. Each o us has a dierent level o comort when it comes to

seeing our investments rise and all in value.

Pck th rh mxA sound mutual und portolio combines a variety o investments that behave dierently at a given

time. While one hopes that each investment will grow over time, each will inevitably have periods

o weak and strong returns, refecting the results o the markets in which it is invested. To the ex-

tent that some o your investments rise while others all, you can reduce the overall level o volatil-

ity in your portolio.

d-C aAnother advantage o mutual unds is that you can invest in them regularly with an allotment or

automatic withdrawal rom your checking account allowing you to take advantage o dollar-cost

averaging.

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This strategy ocuses on investing a predetermined amount o money each month or pay period

in order to take advantage o the daily fuctuations o the stock market. With dollar-cost averag-

ing, you are putting into practice the recommendation o nancial planning proessionals to pay

yoursel rst. Following this strategy can also help you avoid the risk o trying to buy at just the

right time or at just the right price with a lump sum o money.

Dollar-cost averaging does not guarantee a gain, nor can it prevent a loss when the markets are

alling.

rch a sc i Once you have set your goals, established your objectives, determined your time horizons and

understand your risk tolerance, it is time to select a mutual und. Careully read each unds

prospectus and consider the ollowing actors.

aCtors to Consider WHen evaluating mutual unds

aCtor KeY Questions

objc Does the und match your goals and objectives or the long term?

exp How do the unds expenses compare to the average comparable und?

Are there sales charges or 12b-1 ees?

P

m t

How long has the portolio manager been in this role?

Does the und have a strong perormance record created by someone

who has since let?

Pc How does the unds perormance compare to that o its peers?

In addition to the past ew months or year how strong is the unds

long-term perormance?

rk Will you have the perseverance to hold the und when the market is

down?

How does the unds risk level compare to similar unds?

tx Has the und generated large taxable distributions?

Does it have a high portolio turnover rate that may lead to tax ine-

ciency?

Is the und about to make a large capital gain or dividend distribution?

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sc o iThere are several sources o inormation to aid you in nding the right

unds or your portolio.

One especially important source is the mutual unds prospectus. This

is a comprehensive document that mutual und companies are required

to provide you either in print or electronically when you invest in

a und.

Pay special attention to these sections o a mutual und ppc.

i bjc . This section describes the

purpose o the und and how it plans to achieve it.

rk. This is a listing and description o the various risks asso-

ciated with the und, given its objectives and the types o in-

vestments it selects.

rk/r ch.

This bar chart shows the unds annual re-turns or each o the previous 10 calendar years (or, i the und

has existed less than 10 years, or the lie o the und). It pro-

vides insight into the unds historical volatility.

B- -x ch. Most unds are required

to include a chart showing beore- and ater-tax und returns or

the past 1, 5 and 10 years, comparing them to an appropriate

index. Money market unds are required to show only beore-tax

returns. Also, unds without annual returns or at least 1 calen-

dar year cannot include any perormance inormation. Andunds with less than 5 or 10 years o perormance would show

returns since inception and omit the 5- and 10-year return

numbers (as applicable).

b. This describes the unds ees and expenses and

makes it easy to compare the costs o dierent unds. It also

translates percentages into dollars by showing you the costs

associated with an investment o $10,000 over the past

1, 3, 5 and 10 years.

tiCKer sYmBols

Like stocks, mutual

unds are assigned

ticker symbols to aid

investors in research-

ing, buying and selling

shares. All mutual undticker symbols consist

o ve letters, always

ending with an X.

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Another excellent source o inormation is the unds latest annual or

semi-annual report, which provides inormation on the unds perorm-

ance along with commentary rom the portolio manager. These reports

also provide a complete listing o the unds holdings as o the last day

o the reporting period. Beore investing, request the most recent report

or view it on the und companys Web site.

In addition to the und companies themselves, several research organi-zations, including CDA/Weisenberger, Lipper Analytical Services, Morn-

ingstar and Value Line provide independent analysis o mutual unds.

They oer some inormation without charge, yet some reports are avail-

able only by subscription. You may nd their printed subscription

materials at your local library.

m sc icAs you research mutual unds, you will encounter a variety o statistical

measures o risk and other characteristics. These numbers are espe-cially helpul when comparing unds.

e m PcClearly, one o the most important characteristics o a und is its invest-

ment perormance. The best way to evaluate this is to compare a unds

results with those o a benchmark.

Before

investing,

reQuest tHe

most reCent

rePort or vieW

it on tHe fundComPanYs

WeB site.

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One approach to benchmarking is the use o market indexes, which track the perormance o a

specic group o securities. While the Dow Jones Industrial Average is perhaps the best-known

market index, it is not used as a mutual und benchmark as requently as some o the other

indexes listed in the table.

indeX traCKs

s & P 500 Large-cap U.S. stocks.

r 2000 Small-cap U.S. stocks.

nq Cp Over 3,000 stocks traded on the Nasdaq stock market.

dw J u.s. t All U.S. stocks with available price data broadest U.S. marketsck mk ix measure.

msCi eae (ep, Certain oreign stock markets.a, e)

nkk (Jp)daX (gy)

tse (g B)

CaC-40 (c)

dw J 20 B Average price and yield o 10 public utility bonds and 10 industrialbonds.

B By 40 actively traded investment-grade municipal bonds.mcp ix

In addition to comparing a unds perormance with the return on a relevant index, investors can

also compare the unds perormance with that o a group o similarly managed mutual unds.

For example, a und ocusing on large-cap value stocks may be compared to the average peror-

mance o all other large-cap value unds.

The unds annual and semi-annual reports and prospectus should provide both o these compari-

sons or you. A variety o investment research sites on the Internet also urnish this inormation.

When comparing unds to benchmarks, take a long-term perspective. Even the best portolio

managers are not able to exceed their benchmarks over every time period.

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oCusing Your investment strategY

To make the most o your investment activities, nancial planning proessionals recommend you

consider implementing some time-tested strategies.

i

th l t

The more time you give your investment to grow and compound, the

more likely you are to reach your nancial goals. History shows that

patient investors who ocus on long-term goals can withstand fuctua-

tions o the stock market.

u t,

n t

I you start early and invest regularly, you will be able to use time to your

advantage. Do not try timing decisions to buy and sell based on the

market fuctuations. No one has accurately predicted the market fuctua-

tions over the long term.

Kp e o

o Y ac

Investors decisions tend to be infuenced by short-term variables and the

latest news. Think and act intellectually, not emotionally. Investing suc-

cess requires patience, stamina and an unemotional approach. Do your

homework; then stay on course.

ic Y

Kw

Learn all you can about investing and specic investments by regularly

reading business periodicals, investment books and annual reports o

companies whose securities you might want to purchase.

a Hh-rk

i

Avoid utures, commodities and other risky orms o investing at

least until you know all about them and you are willing and able to

accept their increased risks.

a th Cw I you choose your investments by leaping into whatever is currentlydoing very well, you may be setting yoursel up or recurring losses over

time. You could nd that the best perorming stock in 1 year becomes

one o the worst in subsequent years.

dy Select a wide variety o securities or your portolio to minimize invest-

ment risks. Experts suggest that diversication can reduce the total risk

o investing by more than hal. Investing in several assets will produce

a return based on the average o your various investment returns, rather

than relying completely upon the return o one investment.

e Y

i P

Evaluate your investment plan annually or at times o signicant lie

events. I necessary, rebalance your portolio to ensure your mix o

investments aligns with your goals, risk tolerance and the time horizon.

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13resourCes

The USAA Educational Foundation oers the ollowing publications.

BasiC investing (#503)

stoCKs and Bonds (#553)

get investmentWise (#521)

individual retirementaCCounts (ira) (#561)

get moneYWise (#504)

get CreditWise (#534)

managing Credit and deBt (#501)

Building and maintaininggood Credit (#536)

inanCial Planning andgoal setting (#511)

retirement Planning inYour 20 and 30 (#516)

inanCing College (#513)

t cpy y h h pbc,

www.. c (800) 531-6196.

Inormation in this publication was current at the time it was printed. However, the Foundation cannot guaranteethat Web sites, physical addresses and phone numbers listed in this publication have not changed since then.I a Web site address, physical address or phone number has changed since you received this publication, logonto a search engine and type in keywords o the subject matter or organization you are researching to locate suchupdated inormation.

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