CHAPTER 13:

INVESTING INMUTUAL FUNDS

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INVESTORSpool their money and

Mutual Fund Basics

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INVESTORSpool their money and

buy shares in the MUTUAL FUND.

ABC XYZ MUTUAL FUND

Mutual Fund Basics

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INVESTORSpool their money and

buy shares in the MUTUAL FUND.

ABC XYZ MUTUAL FUND

FUND MANAGER selects and purchases a variety of investmentinstruments.

Mutual Fund Basics

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Advantages of Mutual Funds: Diversification—risk is lowered; one share

buys a slice of everything in the fund.

Professional management—pay someone else to make investing decisions.

Financial returns—relatively attractive returns over the long term.

Convenience—easy in & out, small outlays, help with record keeping.

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Disadvantages of Mutual Funds:

No choice in securities selection— if you don’t agree with choices, you must change funds.

No control over sale of securities within fund—timing of sales has tax implications for investor.

13-7How Mutual Funds are Organized: Each fund is a separate corporation or trust and is

owned by the shareholders. Other main players include:

– Management company—runs the daily operations.– Investment advisor—oversees portfolio.– Distributor—sells fund shares. – Custodian—physically safeguards fund’s assets.– Transfer agent—executes transactions and

maintains shareholder records.

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Open-End Investment Companies (mutual funds)

–Dominant type of investment company

–Shares purchased from and sold back to company. Shares are not traded among individual investors.

–New shares issued as money flows in.

–NAV is usually the quoted price.

Types of Investment Companies:

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–Current value of all securities held in fund’s portfolio.

–Open-end funds buy back their own shares at NAV.

Net Asset Value (NAV)

NAV =

Current market price of all fund assets

(Less any liabilities)

Divided by the number of outstanding shares

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–Operate with a fixed number of shares outstanding.

–All trading is done between investors on the open market.

–Shares frequently trade at a discount or premium to net asset value.

Closed-End Investment Companies

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–Typically structured as index funds.• Spiders based on S&P 500• Diamonds based DJIA• Qubes based on Nasdaq 100

–Trade on listed exchanges like closed-end funds.

–Numbers of shares outstanding can be increased or decreased, depending on demand, like open-end funds.

Exchange-Traded Funds

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–Usually sold by brokerage houses.

– Investors purchase a share in an unmanaged pool of investments.

–No trading of securities within the portfolio once the trust assets have been purchased.

–Tend to have relatively high transaction costs and yearly fees.

Unit Investment Trusts

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–Closed-end investment companies whose trust assets are limited to real estate investments.

–Offer a more diverse and marketable way to invest in real estate.

–Equity or property REITs invest in properties; mortgage REITs invest in mortgages; hybrid REITs invest in both.

Real Estate Investment Trusts (REITs)

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Mutual Fund Cost Considerations: Loads = sales commissions

– Front-end load funds (or simply "load funds") charge a commission when shares are purchased.

– Low-load funds hold commissions to 2–3% when shares are purchased.

–Back-end load funds charge a commission when shares are sold.

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12(b)-1 Fees—annual fees for marketing and promotion.

Management Fees—annual fees charged by all funds to pay the fund manager.

No-Load Funds—no fee to purchase or redeem shares and low or no 12(b)-1 fees.

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–Total sales charges and fees cannot exceed 8 1/2%.

–Of this amount, 12(b)-1 fees cannot exceed 1%.

–Funds cannot call themselves “no-load” if their 12(b)-1 fees exceed 0.25%.

Maximum allowable fees:

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–Funds are required to disclose all fees in their prospectus.

–Even no-load funds can have high annual expense ratios and/or 0.25% 12(b)-1 fees.

–Fees affect your return, and annual fees will be collected regardless of the performance of the fund.

Keep Track of Fees!

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Types of Funds Growth Aggressive

Growth Value Equity-Income Balanced Growth & Income Bond

Money Market Index Sector Socially

Responsible International Asset Allocation

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Automatic Investment Plan—mutual fund periodically drafts money from investor's bank account.

Automatic Reinvestment Plan—fund earnings and distributions automatically reinvested in additional shares of fund.

Regular Income—fund automatically pays out to investor predetermined amount periodically.

Services Offered by Mutual Funds:

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Retirement Plans—funds set up and administer retirement plans for self-employed individuals.

Conversion Privileges—allow shareholders to easily move from one fund to another within the fund family.

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Making Mutual Fund Investments

Selecting a Mutual Fund:

Match the fund's objectives with your investment objectives.

Consider your tolerance for risk and your investment time horizon.

Read the prospectus!

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Check the fees charged.

Consider the fund's longer-term returns as well as its shorter-term returns.

Refer to Exhibit 13.8 concerning mutual fund facts every investor should know.

Assess the fund's services.

13-23Mutual Fund Performance: Returns consist of :

1) dividend/interest income earned by the fund assets;

2) realized capital gains distributions from sale of assets within the fund;

3) change in mutual fund's share price.

Past performance reveals success of fund managers but does not guarantee future returns!

THE END!