Mutual Funds
FIN 1050
What We Will Cover
• What is a Mutual Fund?
• Advantages and Disadvantage of
Mutual Funds
• Costs of Mutual Funds
• Types of Mutual Funds
• ETFs
• Buying a Mutual Fund
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What is a Mutual Fund?
• Investors pool their money
• A fund manager buys a variety of
stocks
• Each investor owns a share of the fund
(the total of all the stocks in the fund)
• When the fund increases in value, the
investor makes money
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How Mutual Funds Work
Individuals invest
their savings in
a mutual fund
Mutual Fund
The mutual
fund invests
in a wide
range of
stocks and
bonds
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Net Asset Value
• Mutual funds do not change price
throughout the trading day
• The price you buy and sell for is called
net asset value (NAV) rather than
stock price
• It is updated only once a day, at the end
of the trading day
• NAV equals Total value of securities
minus debts divided by number of
shares
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Open-Ended Funds
• This type of fund
may issue as many
shares as it wishes,
and anyone can
invest
• 95% of funds are
open-ended
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Closed-End Funds
• Closed-end funds
can issue a limited
number of shares
• Investors buy and
sell shares among
themselves
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Advantages of Mutual Funds
• Diversification
• You purchase a small amount of many
stocks without having to physically buy
each stock
• Professional Management
• Fund managers are professionals with
access to better information than the
average investor
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Advantages of Mutual Funds
• Minimal transaction costs
• Individual investors save on brokerage
fees compared to individual stock
purchases
• Liquidity
• Easy to buy and sell
• Flexibility
• There are over 8000 funds to choose from,
allowing you to invest in an area you want
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Disadvantages of Mutual Funds
• Lower-than-market performance
• On average, mutual funds underperform
the market
• Costs
• May charge a sales fee as well as an
annual expense fee that will eat away your
profits
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Disadvantages of Mutual Funds
• Risk
• Depending on the segment of the market
the mutual fund invests, it may do very
well or very poorly
• Systemic Risk
• A market crash will have a negative effect
on your fund
• Taxes
• You have to pay taxes on gains as you go,
except in a retirement account
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Costs of Mutual Funds
• “Load” funds charge a commission to
buy or sell the funds
• Usually 4-8% of the investment
• “Front-end load” means you pay a
commission when you buy
• “Back-end load” means you pay a
commission when you sell the fund
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Costs of Mutual Funds
• “No-load” funds mean you don’t pay a
sales commission, but deal directly
through the investment company
• Some funds will charge a fee if you sell
within a specific period of time, such as
90 days
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Costs of Mutual Funds
• Owners of mutual funds pay an annual
expense
• Known as the expense ratio
• Typically it is .25 to 2 percent of the
investment value
• Try to buy a fund with the lowest
expense ratio possible
• Expenses can eat up all or most of your
profits, especially if the fund isn’t
performing well
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Costs of Mutual Funds
• 12b-1 fee
• These are marketing expenses passed on
to the investor
• They do not benefit the investor at all
• Try to find funds that have minimum or
no 12b-1 fees
• They will eat into your profits and do not
provide any benefit to the investor
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Types of Mutual Funds
• Stock funds
• Most popular types of
funds
• They buy mostly
stocks, but may also
invest in cash, bonds,
and money market
funds
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Types of Stock Funds
• Aggressive Growth Funds
• The fund buys stocks that will (hopefully)
increase dramatically in price
• Very volatile
• Small-Company Growth Funds
• Investments are limited to small
companies
• Volatile
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Types of Stock Funds
• Income Funds
• Concentrate more on strong companies
paying dividends
• Less risky than aggressive growth funds
• Growth-and-Income Funds
• Concentrate on stocks providing dividends
plus the potential for growth
• Less volatile
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Types of Stock Funds
• Sector Funds
• Specializes in stocks from a specific
industry
• Computer, financial services, biotech, etc.
• Index Funds
• This fund tracks a market index such as
the S & P 500, the DOW, or the Nasdaq
• Low expense ratio
• International
• Invests mostly in stocks outside the U.S.
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Types of Mutual Funds
• Balanced funds
• Holds both stocks and bonds
• Asset Allocation
• Balanced funds with market timing
• Life Cycle Funds (relatively new)
• Attempt to tailor holdings to the investor’s
age and risk tolerance
• The fund is managed based on how close
you are to retirement
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Types of Mutual Funds
• Bond funds
• Invest in bonds rather than stocks
• Emphasize income over growth
• Types of bond fund (remember that a
bond is debt issued by a company or
government that must be paid back)
• U.S. Government bonds
• Municipal bonds (bonds issued by city or
state)
• Corporate bonds
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ETFs (Exchange Traded Funds)
• These are a hybrid between mutual
funds and stocks
• Trade throughout the day
• Like a mutual fund in that they are
diversified, but based on an index or
sector of the marketplace
• The biggest are QQQ (tracking the
Nasdaq) and SPDRS (tracking the S & P
500)
• Lower expenses than mutual funds
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Buying a Mutual Fund
• Determine your goals
• What are you investing for?
• Retirement
• Education
• Income
• Growth
• Meeting your objectives
• Make sure the fund meets your goals
(above)
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Evaluate the Fund
• www.morningstar.com identifies funds by
investment strategy and management style
• Look closely at past performance and
expenses
• Compare funds in the same category; do not
compare a growth fund to an international
fund, for example
• Look for “star” ratings (4-star and 5-star
ratings)
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Buying a Mutual Fund
• You can purchase through your
company’s 401(k) website
• You can purchase directly from the
mutual fund company
• You can purchase from your broker
• You can purchase through your bank
• Many funds will let you invest with as
little as $1000 in a retirement account
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