Download Chapter Fifteen

Chapter Fifteen
Investing Through
Mutual Funds
Introduction
• Investment Company – a corporation,
trust, or partnership in which investors
with similar financial goals pool their
funds so as to utilize professional
management and to diversify their
investments in securities and other
investments.
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Introduction (continued)
• Mutual Fund – an investment company that
combines the funds of investors who have
purchased shares of ownership in the
investment company and then invests that
money in a diversified portfolio of stocks and
bonds issued by other corporations or
governments.
• Portfolio – consists of a collection of
securities and other investment alternatives.
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What Investors Expect from Mutual
Funds
• Closed-End Investment Company –
issues a limited and fixed number of
shares and does not buy them back.
• Open-End Mutual Fund – always ready
to sell new shares of ownership and to
buy back previously sold shares at the
fund’s current share price.
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Investors Expect Mutual Fund Dividend
Income
• Mutual Fund Dividends – income paid to
investors out of profits earned by the
mutual fund from the investments it has
made.
– Mutual funds dividends represent current
income to mutual fund shareholders.
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Capital Gains Distributions
• Capital Gains Distributions – represent
the net gains that a fund realizes when
it sells securities that were held in the
fund’s portfolio.
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Investors Expect Capital Gains
Through Price Appreciation
• Mutual fund investors also expect to profit
when they sell their shares.
• Net Asset Value (NAV) – the per-share value
of the mutual fund.
• Unrealized Capital Gains – merely “paper
profits” on the accounts of the mutual fund.
• When such gains are “realized” by the mutual
fund company, they are paid to fund investors
as capital gains distributions.
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Mutual Funds Have Different
Investment Objectives
• Prospectus – a mutual fund’s
investment objectives must be stated in
this.
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Funds with an Income Objective
• Bond Fund – aims to earn current income
without incurring undue risk and to pay
ordinary income dividend distributions.
• Municipal Bond (Tax-Exempt) Fund –
attempts to earn current tax-exempt income
by investing solely in municipal bonds issued
by cities, states, and various districts and
political subdivisions.
• Mortgage Fund – invests in mortgage-backed
securities.
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Funds with a Balanced Objective
• Balanced Funds – invest in a mixture of
bonds, preferred stocks, and blue-chip
common stocks.
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Funds with a Growth Objective
• Growth Fund – seeks long-term capital
appreciation by investing in the common
stocks of companies whose values are
expected to grow faster than usual.
• Value Fund – specializes in growth
stocks whose prices appear to be low,
based on the logic that such stocks are
currently out of favor and under-priced.
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Funds with a Growth Objective
(continued)
• Aggressive-Growth Fund (or Maximum
Capital Gains Fund) – seeks the
greatest long-term capital appreciation
and incurs the greatest fluctuation in the
price of its shares.
• Small-Cap Fund (or Small-Capitalization
Fund) – specializes in investing in
lesser-known mid-sized companies with
market capitalization of less than $1
billion that are expected to grow rapidly.
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Funds with a Growth Objective
(continued)
• Sector Fund – heavily invests in common
stocks from one industry or one portion of the
economy that are expected to grow, perhaps
very rapidly.
• Precious Metals and Gold Funds – seek longterm capital appreciation by investing in
securities associated with gold, silver, and
other precious metals.
• Global Fund – invests primarily in growth
stocks of companies listed on foreign
exchanges.
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Funds with a Growth and Income
Objective
• Growth and Income Fund – objective is
a combination of growth and income;
invests in companies expected to show
average or better growth and to pay
steady or rising dividends.
• Life-Cycle Funds – create a diversified,
all-in-one portfolio for those individuals
who do not wish to actively manage
their own investments.
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Funds with a Growth and Income
Objective (continued)
• Socially Conscious Funds – usually
invest in firms with good records on the
environment, human rights and public
safety.
• Mutual Fund Funds – earn a return by
investing in other mutual funds, thereby
providing extensive diversification.
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Unique Features of Mutual Funds
• Easy Purchase and Sale – after you have
opened an account with a mutual fund
company, you can easily buy and sell shares.
• Check Writing and Wiring of Funds
• Automatic Investment – Most funds allow
investors to make periodic monthly or
quarterly payments using money
automatically transferred from their bank
account to the mutual fund company.
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Unique Features of Mutual Funds
(continued)
• Automatic Reinvestment – allows for the
automatic use of ordinary income
dividend distributions, capital gains
distributions, and interest to buy
additional shares of the fund without
paying any commissions.
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Figure 15.2: The Wisdom of Automatic
Reinvestment
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Switching Privileges within a Mutual
Fund Family
• Switching Privilege (or Exchange Privilege) –
permits mutual fund shareholders to easily
swap shares on a dollar-for-dollar basis for
shares in another mutual fund within a mutual
fund family.
• Exchange Fee – a small charge, typically $5
or $10 per transaction, on a transfer from one
fund to another.
• Mutual Fund Family – exists when the same
management company operates a variety of
mutual funds, each with its own investment
objectives.
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Recordkeeping and Help with Taxes
• Confirmation Statements – indicate the
number of shares owned and the value
of the holdings.
• Consolidated Statements – report all of
the investor’s holdings and transactions
in the mutual fund family.
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Beneficiary Designation
• Beneficiary Designation – enables the
shareholder to name one or more
beneficiaries so that the proceeds to go
them without going through probate.
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Withdrawal Plans
• Withdrawal Plans (or Systematic Withdrawal
Plans) – available to shareholders who want
a periodic income from their mutual fund
investments.
• You can take your funds out of a mutual fund
using one of four methods:
–
–
–
–
By taking a set dollar amount each month.
By cashing in a set number of shares each month.
By taking the current income as cash.
By taking a portion of the asset growth.
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Mutual Fund Transaction Fees
• You may be required to pay a
transaction fee when you purchase and
sell your mutual fund shares
• Load funds always charge transaction
fees
– Sales Charge (or Commission or Load) –
assessed by some mutual funds at the
time of purchase.
– Front-End Load – the commission paid to
the salesperson.
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Mutual Fund Transaction Fees
(continued)
• No-Load Funds Sometimes Charge
Transaction Fees
– No-Load Fund – a mutual fund that does
not assess a sales charge at the time of
the investment purchase.
– Note that the SEC allows funds to be
called “no-load” if they assess a “service
fee” of 0.25 percent or less when shares
are purchased.
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Mutual Fund Transaction Fees
(continued)
• Deferred Load (or Back-End Load) – a
sales commission that is imposed only
when shares are sold.
• Redemption Charge (or Exit Fee) –
typically disappears after the investment
has been held for six months or a year.
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Mutual Fund Expense Charges
• Management Fee – an annual
assessment to pay the advisors who
operate the mutual fund.
• 12b-1 Fee (or Distribution Fee) – an
annual charge deducted by the fund
company from a fund’s assets to pay for
advertising, marketing, distribution, and
promotional costs.
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What’s Best: Load or No-Load? LowFee or High-Fee?
• Up-front load charges are costly to the
investor in the short run (less than five
years), whereas annual 12b-1 charges
are very costly over the long run.
• Over five-year periods, lower-cost funds
always deliver returns better than those
offered by higher-cost funds.
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Managed Funds or Index Funds?
• Managed Funds – professional managers are
constantly evaluating and choosing securities
using a specific investment approach.
• Index Fund – a mutual fund that simply buys
and holds the stocks or bonds that constitute
a market index.
• Unmanaged Funds – managers do not
evaluate and select individual securities, but
rather buy and hold all the stocks in a
particular index.
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Figure 15.3: Balancing Risk and
Returns on Mutual Funds
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Interpret Comparative Performance
Information Over Time
• Consider a fund’s volatility – volatility
characterizes a security’s or mutual
fund’s tendency to rise or fall in price
over a period of time.
• Consider a fund’s long- and short-term
performance
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