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Chapter 13

Investing in Mutual Funds


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.

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


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 funds stated objective

Financial Intermediary

Why Investors Purchase Mutual Funds

Professional management
Who is the funds manager?
How has the fund performed under the current managers?

Investors funds are used to purchase a variety of investments Risk reduction

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

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


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


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 Shares Outstandin g

NAV calculated at the close of trading


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)


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 investors financial goals

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


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


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

Typical Mutual Fund Fees


Objective 2
Classify Mutual Funds by Investment Objective
Long-term Funds

Stock Funds

Bonds Funds

Other Funds


Stock Funds
Long-term Funds Stock Funds Bonds Funds Other Funds

Aggressive Growth Growth Equity income Small-cap Mid-cap Large-cap Global Regional International Index funds Sector funds Socially responsible

Price growth vs. Dividend Income

Company Size

% U.S. vs. International Match index holdings Economic Sectors Invest in socially responsible firms

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

Other Funds
Long-term Funds Stock Funds Bonds Funds Other Funds

Asset Allocation Funds Balanced Funds Fund of Funds Lifecycle Funds Money Market Funds


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


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 funds portfolio Index fund securities held by the fund replicate those contained in a specific index like the S&P 500


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




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

Mutual Fund Prospectus

Fund objective(s) Statement describing the risk factors Description of the funds past performance Statement describing the type of investments in the funds portfolio Information about dividends, distributions and taxes Information about the funds management Information about limitations or requirements for the fund Procedure to buy or sell shares Services provided to investors Turnover ratio of the funds investments

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 Weeks mutual fund survey includes:
Funds 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

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


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

Purchase Options
Fund Type Closed End Exchange Traded Open End No Load Purchase From Stock exchange or Over-the-counter market Fund Management Co. Authorized Agent Fund Supermarket*


* Investor may deal with one company, get one statement, yet have a choice of a wide variety of funds


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


Withdrawal Options
Closed-end funds & exchange-traded

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

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




Additional Video
Mutual Fund Awards BusinessWeek and S&Ps Best Fund Picks (Instructors see the notes section for directions.) SYNOPIS: Helpful information about how BusinessWeek and Standard & Poors 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 & Poors 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?