© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

16-1

CHAPTER 16

Personal Finance

Investing in Mutual Funds

Kapoor Dlabay Hughes

7e

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

What is a Mutual Fund? An investment chosen by people whose

money is pooled with other investors to buy stocks, bonds, and other financial securities selected by professional managers who work for investment companies.

An investment company is a firm, that for a management fee, invests the pooled funds of small investors in securities appropriate to the fund’s stated objective.

16-2

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

What is a Mutual Fund? (continued)

There are over 8,000 funds to choose from. Many people choose mutual funds for their

retirement account investments. 401(k) or 403(b) IRA Roth IRA

16-3

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Why Investors Purchase Mutual Funds

Professional management. Who is the fund’s manager? Managers can change.

Diversification. Investors funds are used to purchase a

variety of investments. This variety provides some safety.

16-4

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Closed- and Open-End Funds Closed-end funds (6% of funds).

Shares are issued by an investment company only when the fund is organized.

After all original shares are sold you can purchase shares only from another investor who is willing to sell.

Open-end funds (93% of funds). Shares are issued and redeemed by the

investment company at the request of investors. Investors are free to buy and sell shares at the

net asset value (NAV). 16-5

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Exchange-Traded Funds

Invests in the stocks contained in a specific stock market index, like the Standard and Poor’s 500 stock index.

Performance of shares in the fund tend to mirror the performance of the index.

Low management fees since there is less need for decisions made by a portfolio manager.

16-6

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Net Asset Value (NAV)

Value of the fund’s portfolio - Liabilities

Number of shares outstanding

Offer price = NAV + sales commission

16-7

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Load Funds and No-Load Funds Load Fund.

Investors pay a commission (sales charge) up to 8.5% every time they purchase shares. This is sometimes called a front load.

Average charge is 3-5% for which an investor can get purchase advice and explanations.

No-Load Fund. Investors pay no sales charge up front. You deal directly with the investment

company via 800 numbers or web sites, or from discount brokers.

16-8

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Management Fees and Other Charges Management fee.

Charged yearly (.25%-1.25% average) based on a percentage of the funds asset value.

Contingent deferred sales load (back-end load). Charged upon withdrawal of funds (1-5%). Generally decreases on a sliding scale depending

on the number of years shares are held. 12b-1 fees.

Annual fee to defray advertising and marketing costs of the fund.

Approximately 1% of a fund’s assets per year.16-9

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Number of Mutual Funds by Type*

0500

1,0001,5002,0002,5003,0003,5004,0004,500

EquityFunds

Bond Funds HybridFunds

MoneyMarket,Taxable

MoneyMarket, Tax

Exempt

16-10*Source: Year 2000 data from the U.S. Bureau of the Census, Statistical Abstract of the United States, 2001, page 744.

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Classification of Mutual Funds Stock funds.

Aggressive growth funds buy stocks in small, fast-growing companies.

Growth buy stock in companies with higher- than-average revenue and earnings growth.

Growth and income buy stock in growth companies, plus stock in companies with a predictable source of dividend income.

Equity income funds invest in stock of companies with a long history of paying dividends.

Index buys stocks that mirror an index.

16-11

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Classification of Mutual Funds

Global funds buy stock in companies in the U.S. and other countries, while international funds buy stock only in companies outside the United States.

Regional funds buy stock in companies in a specific region of the world.

16-12

(stock funds continued)

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Classification of Mutual Funds Sector funds buy stock in companies in a

particular sector such as biotechnology. Large-cap funds buy stock in very large

companies whose capitalization may be in the billions, while mid-cap funds buy stock in companies with a capitalization of 500 million or more.

Small cap funds buy stock in lesser-known companies with a capitalization of less than 500 million.

16-13

(stock funds continued)

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Classification of Mutual Funds

Bond funds. Municipal bonds funds buy municipal bonds with tax-

free interest income. Insured municipal bonds provide tax-free income

insured against default. Long-term U.S. bonds with maturities of greater than

10 years. Intermediate U.S. bond funds buy treasury notes with

maturities of 5-10 years. Short-term U.S. bond funds invest in U.S. Treasury

issues of 1-5 years.

(continued)

16-14

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Classification of Mutual Funds Short-term corporate bonds with maturities

of 1-5 years. Intermediate corporate bonds (5-10 years). Long-term corporate bonds (> 10 years). High-yield (junk) bonds buy corporate bonds

that are higher risk. World bond funds buy bonds of foreign

companies and governments.

(continued)

16-15

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Classification of Mutual Funds Other funds.

Balanced funds. Invest in both stocks and

bonds with the primary objective of conserving principal.

Money market funds. Invest in CDs, government securities and

other safe and liquid investments. Asset allocation funds invest in various asset

classes, with precise amounts within each type.

(continued)

16-16

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Families of Funds

A family of funds exists when one investment company manages a group of mutual funds.

Each fund in the family has a different financial objective.

Exchange privileges allow you to move your money from one fund to another within the fund family with low or no charge.

16-17

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Steps to Evaluate Mutual Funds

Perform a financial checkup to make sure you are ready to invest.

Determine your risk tolerance. Determine your investment objectives. Obtain the money you need to purchase mutual

funds. Find a fund with an objective that matches your

objective. Evaluate, evaluate, and evaluate any mutual

fund before buying or selling. 16-18

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Reading a Mutual Fund Quotein the Newspaper

Net asset value and asset value change. The fund family and fund name. Fund objective. Total return over various time periods. Ranking among funds with the same

objective. Sales load fees if any, or no load (NL). Annual expenses.

16-19

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Other Sources of Fund Information

Mutual fund prospectus tells the funds objective, plus.. A statement describing the risk factors. A description of the fund’s past performance. A statement describing the type of investments in the

fund’s portfolio. Information on how to open an account. Dividends, distributions and taxes. Information about the fund’s management. The process for investors to buy or sell shares. Services provided to investors. The turnover ratio of the fund’s investments.

16-20

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Other Sources of Fund Information Mutual fund annual report.

Performance, investments, assets and liabilities. Financial Publications.

Business Week, Forbes, Kiplinger's Personal Finance and Money are sources of information.

Business Week’s mutual fund survey includes information such as the...Fund’s 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.

16-21

(continued)

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Internet Sources of Fund Information

Use web sites to research a fund. www.finance.yahoo.com www.businessweek.com www.morningstar.net www.smartmoney.com

Check mutual fund companies Internet sites. www.troweprice.com www.vanguard.com

16-22

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

16-23

Who Owns Mutual Funds by Age*

2%18%

28%

25%

27%

Less than age 2525-34 years old34-44 years old45-54 years oldOver 55 years old

*Source: Year 2000 data from the U.S. Bureau of the Census, Statistical Abstract of the United States, 2001, page 744.

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Mutual Fund Transactions

You can open an account from $250 to $3,000 and up depending on the fund family and the fund.

Open-end, no-load directly from the investment company by phone or through the mail, or from a discount broker.

Closed-end or exchange-traded funds are purchased via a broker through the stock exchange.

16-24

© The McGraw-Hill Companies, Inc., 2004. All Rights Reserved.

Irwin/McGraw-Hill

Mutual Fund Transactions There are several ways you can get a return on

your investment. You have capital gains when you sell shares

at a higher price than you paid. There may be income distributions when your

fund sells securities. Capital gain distributions are made. Income and capital gain distributions can be

automatically reinvested. Keep accurate records for tax purposes, as

gains and income are subject to taxation. 16-25