powerpoint slides
DESCRIPTION
TRANSCRIPT
Planning Your Financial Future, 4eby: Boone, Kurtz & Hearth
Mutual Funds
Chapter 14
2
Understanding Mutual Funds
A pool of money from numerous investors used to invest in a portfolio of securities—managed by a professional portfolio manager
When you own shares in a mutual fund, you own a small part of the portfolio
Distributions of interest income, dividend income and capital gain/losses occur to investor in terms of the proportion of the total number of mutual fund shares owned
3
Understanding Mutual Funds
There are over 8,000 mutual funds today Compared to about 600 in 1980
The net assets of mutual funds is about $7.5 trillion
Why are they so popular? Bull market for stocks and bonds Growth of self-directed retirement plans
4
Figure 14.1: Growth of Mutual Funds
Source: Based on data from the Investment Company Institute.
5
How a Mutual Fund Operates
A mutual fund raises money by selling shares of the fund to the investing public
The funds are used to purchase assets such as stocks, bonds, money market securities, etc.
The shareholder of the mutual fund is said to indirectly own the assets held by the mutual fund
AKA open-ended investment companies Constantly issues new shares and redeems
existing shares
6
How a Mutual Fund Operates
The fund’s NET ASSET VALUE represents The market value of the fund’s assets,
less any liabilities, divided by the number of shares outstanding
7
How To Buy Mutual Fund Shares
Can purchase either Through your stockbroker or Directly from the mutual fund
Check the fund’s Web site
Review the fund’s prospectus States the fund’s investment objectives, types
of securities it can purchase, fees, recent performance
Send in your application along with a check
8
Services Offered
Automatic reinvestment of distributions Effectively increases the number of shares you
ownAutomatic investment plans
Can be as little as $50 a monthExchange privileges
Transfer within fund family Check writing
Mostly money market funds (and a few others) allow minimum checks ($500+ each)
Doesn’t replace a regular checking account
9
Regulation and Taxation
Regulated by SEC Must present certain types of information in
prospectus and other reports Limits types of advertising
If mutual fund retains investment profit, it must pay taxes on it; therefore, most mutual funds distribute the gains to shareholders Shareholders must report these distributions
for tax purposes, as well as any gain/loss on redemption of shares
10
Where to Get Mutual Fund Information
InternetMoney’s February issue is heavily
devoted to mutual funds The Wall Street Journal publishes a
mutual fund section regularly
11
Classifying Mutual Funds
Can be classified based on Investment objectives Investment style Types of securities owned by fund
Stocks Bonds (or income) Hybrid (balanced) Money market
12
Figure 14.2: Distribution of Mutual Fund Assets
Source: Based on data from the Investment Company Institute.
13
Classifying Mutual Funds
Common subcategories for stock funds Aggressive growth Growth and income Long-term growth Small-company growth International
Common subcategories for bond funds Government High-yield corporate (junk bonds) Investment-grade corporate World income Mortgage-backed securities Municipal bond
14
Classifying Mutual Funds
Common subcategories for money market funds Government Taxable Tax-exempt
15
Mutual Fund ‘Styles’
Even mutual funds that fall into the same subcategory can have different management styles One fund may try to achieve growth by
investing in stocks with potential for strong earnings growth; whereas
Another fund may try to achieve same objective by selecting stocks it currently believes to be currently undervalued in the market
16
Different Fund Types
Some fairly new fund types Asset allocation funds
Invest in a mixture of stocks, bonds, and money market instruments, shifting allocation of money in an attempt to gain high returns with low risk
Index funds Attempt to replicate performance of a major stock index
(most popular is S&P 500) Why are these so appealing?
Very low fees (not that much management to be done) Most mutual fund managers can’t consistently outperform
the market Sector funds
Invest only in one industry
17
Advantages of Mutual Funds
Diversification Can increase your return without
increasing your risk (or may even reduce your risk) But doesn’t eliminate risk!
Not all mutual funds are diversified—they’re not meant to be
18
Advantages of Mutual Funds
Smaller minimum investments Can purchase a piece of a well-diversified
portfolio for a relatively small investment Money market mutual funds minimum
investment $1,000 Stock and bond mutual funds minimum
investment $1,000–$3,000 (less for IRAs) Additional investments can be as little as $50–$100 Many funds offer automatic investment plans that
require initial investments of as little as $50
19
Advantages of Mutual Funds
Professional management Do all mutual funds always beat the
market? Over the past 10 years, stock funds have
had an average annual return about 1.5% less than the S&P 500 (9% vs. 10.5%)
20
Picking the Right Mutual Funds
Step 1: Choose your investment goals and assess your risk/return position You can then identify the types (group)
of mutual funds that meet your criteria
Step 2: Assess the fees and performance of the mutual funds
21
Fees and Expenses
Several types of fees Load charges: fees associated with either
buying or redeeming mutual fund shares Front-end – paid when shares are purchased
Cannot exceed 8.5% Example: You deposit $1000 in a fund with a 2% front-
end load—only $980 goes toward purchase of shares, the remaining $20 is a fee
Most funds use front-end loads with very few actually charging the maximum 8.5%
Redemption fee (back-end load) – paid when shares are sold
Often depends on how long the shares were owned—with a lower fee charged for a longer holding period
22
Fees and Expenses
Trend is toward low front-end loads or no-loads No charges associated with buying or selling the mutual
fund
Over half of all mutual funds are no-load Annual operating expenses
Includes fees paid to portfolio manager, transaction costs, printing costs
Paid from investment income before it is distributed Average is about 1.5% for stock funds; 1.1% for bond funds
12b-1 fees Pays for distribution costs (such as advertising) in lieu of a
load charge
23
Fees and Expenses
Evaluating fees and expenses Not all funds charge the same operating fee %
—shop around Can range from 0.1% to 2.5+% Fees and expenses can have a dramatic impact
on the value of your investment over time No definitive evidence shows that funds
charging higher fees earn higher returns Everything else being equal, you’re better off buying
a no-load fund with low operating costs
24
Performance
Need to examine absolute performance AND relative performance as well as risk
When comparing fund to a benchmark, choose the right benchmark
25
The Relationship Between Past and Future Performance
Some funds beat the market some years and not others Should we try to predict which funds will beat
the averages next year (or during the next 5 years) or not? Randomly choosing funds will probably lead to the
same results according to some people Others argue that superior funds may
underperform some years, but over the long run produce superior returns
26
The Relationship Between Past and Future Performance
Results are mixedConclusion
Don’t chase returns—the fees are too great and your results probably won’t be stellar
Past performance in NO WAY GUARANTEES FUTURE PERFORMANCE
27
Performance and Taxes
Mutual funds pass investment income and realized capital gains to shareholders, so taxes must be paid on these distributions
The more distributions paid to you, the more taxes you’ll pay
28
When Not to Buy Mutual Fund Shares
Most mutual funds have regularly scheduled distribution dates
For tax purposes, you shouldn’t buy shares in a mutual fund right before a distribution You’d owe taxes on that immediate
distribution
29
What About Index Funds
Designed to track performance of a broad stock or bond market index Most popular track the S&P500
Number of index funds has grown rapidly
30
Making Changes to Your Mutual Fund Investments
Will your goals remain the same for the next 30–40 years? No—the mix of your investments will
need to change over time
You’ll also need to rebalance over time Adjusting investments periodically to
return to the target asset allocation
31
When to Sell a Mutual Fund
One reason many people sell shares is due to poor performance BUT, selling shares based on poor short-term
performance may be a bad idea Are you chasing past returns?
This rarely produces superior returns over the long run
Even the best funds have poor performance at times
If you have a good fund, keep it even if it offers poor short-term performance
32
When to Sell a Mutual Fund
There are viable reasons for selling a fund Performance lags behind the
benchmarks for an extended time period (three years or so)
Fund gets very large very fast Expenses keep rising
Fund is trying to capitalize on its popularity Management turnover