13-1

McGraw-Hill/Irwin Copyright © 2006 The McGraw-Hill Companies, Inc. All rights reserved.

13 Investing in Mutual Funds

13-3 Investment in Mutual Funds

1. Describe the characteristics of mutual fund investments

2. Classify mutual funds by investment objectives

3. Evaluate mutual funds4. Describe how and why mutual funds are

bought and sold

Chapter Objectives

13-4 What is a Mutual Fund?

An investment chosen by people who pool their money to buy stocks, bonds, and other financial securities selected by professional managers who work for investment companies.

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

13-5 What is a Mutual Fund?

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

(continued)

13-6 Why Investors Purchase Mutual Funds

Professional management.– Who is the fund’s manager?– How has the fund performed under the current

managers? Diversification.

– Investor’s funds are used to purchase a variety of investments. This variety provides often provides an element of safety.

13-7Objective 1: describe the characteristics of mutual fund investments

Characteristics of Mutual 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).

13-8 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.

13-9 Net Asset Value (NAV)

Value of the fund’s portfolio – Liabilities

Number of shares outstanding

13-10 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 an “A” fund.

– 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.

13-11 Management Fees and Other Charges

Contingent deferred sales load (back-end load or “B” fund).– Charged upon withdrawal of funds (1-5%).– Generally decreases on a sliding scale depending on the

number of years shares are held. Management fee.

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

12b-1 fees.– Annual fee to defray advertising and marketing costs of the

fund.– Approximately 1% of a fund’s assets per year.

13-12 Number of Mutual Funds by Type*

0500

1,0001,5002,0002,5003,0003,5004,0004,5005,000

EquityFunds

Bond Funds HybridFunds

MoneyMarket,Taxable

MoneyMarket, Tax

Exempt

*Source: Year 2000 data from the U.S. Bureau of the Census, Statistical Abstract of the United States, 2004, page 761.

13-13 Objective 2: Classify mutual funds by investment objectives

Classification of Mutual Funds Stock funds.

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

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

– Global funds buy stock in companies in the U.S. and other countries.

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

– Index buys stocks that mirror an index.

13-14 Classification of Mutual Funds

– International funds buy stock only in companies outside the United States.

– Midcap funds buy stock in companies with total capitalization of at least $500 million.

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

(stock funds continued)

13-15 Classification of Mutual Funds

– Sector funds buy stock in companies in a particular sector such as biotechnology.

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

(stock funds continued)

13-16 Classification of Mutual Funds

Bond funds.– High-yield (junk) bonds buy corporate

bonds that are higher risk.– Intermediate corporate bonds (5-10 years).– Intermediate U.S. bond funds buy treasury notes

with maturities of 5-10 years.– Long-term corporate bonds (> 10 years).– Long-term U.S. bonds with maturities of greater

than 10 years.

(continued)

Treasury BondTreasury Note

13-17 Classification of Mutual Funds

– Municipal bonds funds buy municipal bonds with tax-free interest income.

– Short-term corporate bonds with maturities of 1-5 years.

– Short-term U.S. bond funds invest in U.S. Treasury issues of 1-5 years.

(continued)

13-18 Classification of Mutual Funds

Other funds.– Asset allocation funds invest in various asset

classes, with precise amounts within each type.– 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.

(continued)

13-19 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.

13-20 Objective 3: Evaluate mutual funds

The Difference between a Managed Fund and an Index Fund

A managed fund is a fund where managers make the decisions about what securities are included in the fund’s portfolio.

An index fund is a fund that invests in the securities contained in a specific index like the S&P 500.

13-21 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– www. putnam.com– www.americanfunds.com

13-22 Mutual Fund Prospectus

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.

13-23 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.

13-24Reading a Mutual Fund Quote in the Newspaper

Net asset value and net change.

The fund family and fund name.

Fund objective.

Total return over various time periods.

13-25 The Mechanics of Mutual Fund Transactions

There are several ways you can get a return on your investment.– There may be income distributions when your fund makes

payments to shareholders that result from dividend and interest income.

– Capital gain distributions are made to shareholders when the fund buys and sells securities in the fund.

– You have capital gains when you sell shares at a higher price than you paid.

– Keep accurate records for tax purposes, as income distributions, capital gain distributions, and capital gains are subject to taxation.

13-26 Objective 4: Describe how and why mutual funds are bought and sold

The Mechanics of 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. In addition to just selling shares, there are numerous

withdrawal options.