Chapter 15
Investing Through
Mutual Funds
Learning Objectives
1. Describe the features, services, and
advantages of investing in mutual funds.
2. Differentiate mutual funds by investment
objectives, types, and characteristics.
3. Summarize the fees and charges involved in
buying and selling mutual funds.
4. Establish strategies to evaluate and select
mutual funds that meet your investment goals.
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Why Invest in Mutual Funds?
• Mutual funds pool the invested funds of many
investors and use them to invest in a diversified
portfolio.
• Net Asset Value (or NAV): Per-share value of a
mutual fund.
– Assets of the fund less its liabilities
– Divided by the number of shares outstanding
• Dividend income and capital gains
– Ordinary income dividend distributions
– Capital gains distributions
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How a Mutual Fund Works
• Most 401(k) plans invest in shares of mutual funds
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Sources of Investor
Returns from Owning Mutual Fund Shares
<<Insert Figure 15.2 (p. 435) here>>
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Advantages of
Investing Through Mutual Funds
• Diversification
– Random (or nonsystematic) risk
• Affordability
• Professional management
– Fund investment advisers
• Liquidity
• Low transaction costs
• Uncomplicated investment choices
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Mutual Fund Services
• Convenience
• Ease of buying and selling shares
• Check writing and electronic transfers
• Distribution or automatic reinvestment of income and
capital
• Telephone and internet exchange privileges
– Exchange (or switching, conversion, or transfer)
privilege
• Beneficiary designation
• Automatic investment
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The Wisdom of
Automatic Dividend Reinvestment
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Types of Investment Companies
• Closed-End Mutual Fund – issue a limited and fixed
number of shares and issuer does not buy them back.
• Real Estate Investment Trust (or REIT) – Investments
made in assets such as properties, offices, shopping
centers or mortgages. No predetermined life span
• Unit Investment Trust (or UIT) – one time public
offering for a fixed maturity security such as a municipal
bond. Each unit is a proportionate ownership interest in
the specific portfolio.
• Exchange-Traded Fund (or ETF) – Passively managed
securities like an index fund which owns all or a set
amount of securities that duplicate the performance of a
market segment such as the S&P 500, Dow Jones, etc.
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Fund Objectives,
Types, and Characteristics
• Managed Funds – A professional manager with
oversight who constantly evaluates and chooses
securities to buy or sell using a specific
investment approach.
• Income Objective – Invests in securities that pay
regular income in dividends or interest.
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Fund Objectives,
Types, and Characteristics
• Money Market Funds
– Tax-exempt money market funds – municipal
securities with maturities of 90 days or less
– Government securities money market funds –
Appeal to investors who prefer safety by investing
exclusively in U.S. Treasury bills and other short term
securities.
• Bond funds
– Bond (or fixed-income) funds – Goal of earning
income higher than a money market fund without
incurring undue risk by investing in a portfolio of
bonds as well as some preferred stock and common
stock that pay high dividends.
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Fund Objectives,
Types, and Characteristics
• Growth objective
– Aggressive growth
(or maximum capital gains) funds – seek the greatest long-term
capital appreciation. Investments made in speculative stocks
with volatile price swings.
– Growth funds – long term growth by investing in common
stocks of companies with higher than average revenue and
earnings growth. Large, well established firms.
– Growth and income funds – A balanced return made up of
current income and capital gains appreciation. Companies who
expect average or better growth and pay steady or rising
dividends.
– Value funds – Stocks whose prices appear to be low (low P/E)
and undervalued
– Sector funds – Concentrate holdings in one or more industries
that make up a targeted part of the economy expected to grow.
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Fund Objectives,
Types, and Characteristics
• Index Funds: These funds are unmanaged.
• Growth and income objective
– Growth and income funds – Companies which expect average
or better growth and pay steady or rising dividends.
– Equity-income funds - Well-known companies with long history of
paying high dividends with emphasis on income and capital preservation
– Socially conscious funds – environmental or community
involvement organizations that promote moral or ethical behavior.
– Asset allocation funds – asset allocation based upon mix of risk
tolerance (aggressive, moderate, conservative)
– Life-cycle funds - Shift allocation based upon change in risk tolerance
due to age.
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Fees and Charges of
Mutual Fund Investing
• Shareholder Fees – occur per transaction such
as purchase, redemption or exchanges.
• Annual Fund Operating Expenses – operating
costs that are deducted from fund assets before
earnings are distributed to shareholders.
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Load and No-Load Funds
• Load funds always charge transaction fees.
– Front-end load – Sales charge paid when an individual
buys an investment reducing the amount available to
purchase fund shares. (Max 8.5% permitted by SEC)
– Stated commission – percent of commission charged.
– Percentage of the amount invested – actual percent
based upon net amount available for investment
• Some no-load mutual funds assess 12b-1 fees.
– 12b-1 (or distribution) fee – assessed annually to
compensate underwriters and brokers for fund sales
and to compensate for marketing and advertising
expenses and range from 0.75% to 1 %
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Load and No-Load Funds
• Some no-load funds assess deferred load and
redemption fees.
– Deferred (or back-end) load – Sales
commission imposed only when shares are
sold. Charges are on a sliding scale with the
fee dropping 1% per year the investor
remains in the fund.
– Redemption charge (or exit fee) – used to
reduce excessive trading of fund shares.
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Process of
Selecting Mutual Fund Investments
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Selecting Funds in Which to Invest
• Screen and compare funds that meet
your investment criteria.
– Fund screener (or fund screening tool)
– http://finance.yahoo.com/funds
– http://kiplinger.com/investing/funds/
– http://personal.fidelity.com/products/funds/
– Profile prospectus (or fund profile) – describes mutual fund,
its investment objectives and how it achieves its objectives.
– The prospectus includes a standardized expense table which
describes the effects of all fees and expenses.
– Note the expense ratio which is the expense per dollar of
assets under management. Avg. is 1.45% for diversified
stock funds and 0.25% for index funds.
• Monitor your mutual fund portfolio. – use of the internet or
newspapers is a good source
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Balancing Risk
and Returns on Mutual Funds
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How Mutual Funds Are Quoted
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How Mutual Funds Are Monitored
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The Top 3 Financial Missteps
In Mutual Fund Investing
People experience challenges in mutual fund
investing when they do the following:
1. Buy funds with high fees and expenses.
2. Withdraw dividends rather than reinvesting.
3. Chase performance by investing in “hot”
funds.
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Good Money Habits
in Mutual Funds
• Match your investment philosophy and financial goals to
a mutual fund’s objectives.
• Invest only in no-load mutual funds that have low
expenses
• Get the right mix of asset classes in your long-term fund
investments and learn to love consistency.
• Sign up for automatic reinvestment of your mutual fund
dividends.
• Invest regularly through your employer’s retirement plan.
• Rebalance your portfolio at least once a year and dump
the slackers.
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