Mutual Funds by R4fQpPOC



 Mutual Funds
 Chapter Sections:
 Advantages and Drawbacks of Mutual Fund Investing
 Investment Companies and Fund Types
 Mutual Funds Operations
 Mutual Funds Costs and Fees
 Short-Term Funds
 Long-Term Funds
 Mutual Fund Performance
 Closed-End Funds, Exchange Traded Funds, and Hedge Funds

                 Mutual Funds: Investments for the Masses

What is a Mutual Fund?
   An investment company that invests its
    shareholders’ money in a diversified portfolio
    of securities
       “Investment company” is the legal term
       “Mutual fund” is the popular term
       Professional management
       Diversification
   Each fund has a specific objective
   Over 10,000 funds to choose from
   Many people choose mutual funds for their
    retirement account investments (401k, 403b,
    Traditional IRA, Roth IRA, etc.)

Mutual Funds
STOCKS              BONDS                 “CASH”
          mutual          Bond
Stock     funds           mutual
mutual                    funds
funds                                            Money

                                   a “mutual” fund
                              a.k.a. investment company

                     Professional Money Management

Growth of Mutual Fund Industry
                                               Number of
                   Year                       Mutual Funds
                   1940                            70
                   1970                           350
                   1980                           600
                   1990                          2,000
                   2000                          9,000
                   2011                         10,664*
 Source: Investment Company Institute,, *Includes open-end, closed-end, and ETFs

Growth of Mutual Fund Industry                                                         (continued)

    In 1980, five million Americans owned funds
        Holding 3% of their household financial assets
    As of December 2011, 92 million Americans in
     52 million households owned mutual funds
        That is approximately 44% of all U. S. households
        Mutual fund assets totaled $13.0 trillion dollars*
           Holding 23% of their household financial assets
        Mutual funds are now the nation’s largest financial
           intermediary, followed by commercial banks (second
           largest) and life insurance companies (third largest)
      Source: Investment Company Institute,, *Includes open-end, closed-end, ETFs, and UITs as of
December 2011. By the way, at the end of 2010, the amount was $13.1 trillion; at the end of 2009, the amount was
    $12.16 trillion; at the end of 2008, it was $10.35 trillion, and at the end of 2007, it was $12.98 trillion dollars.
                                                                                          2008 was a very rough year.

Advantages of Mutual Funds
   Pooled Diversification
     A process whereby investors buy into a
      diversified portfolio of securities for the collective
      benefit of the individual investors
        This variety provides some safety that is difficult for
        an individual investor to obtain on their own
 Professional management
   The mutual fund managers are supposed to know
    what they are doing
        (They are certainly getting paid enough!)
   Low initial outlay of capital
     You can start with $25 to $50 per month
   “PITA” factor is low –      The Wealthy Barber

Drawbacks of Mutual Funds
   Transaction Costs
     Some mutual funds charge sales fees called
       Front-end loads, back-end loads, etc.
     Many others are “no-load” funds
       But some “no-load” funds can wind up costing you
        more than “load” funds over time
 Annual Operating Expenses
   Typically from 0.5% (or less) to 2.5% (or more)
   Many mutual funds do not match the market’s
     What? Aren’t the mutual fund managers
      supposed to know what they are doing?

Open-end versus Closed-end Funds
   Open-end mutual funds (>90% of mutual funds)
     A type of investment company in which investors
      buy shares from, and sell them back to, the mutual
      fund itself, with no limit on the number of shares
      the fund can issue
     Shares are issued and redeemed by the
      investment company at the request of investors
     Investors can buy shares from (purchase) and sell
      shares to (redeem) the investment company at any
       When people refer to a mutual fund, they are almost exclusively
referring to an open-end mutual fund. As of December ‘11, there were
 8,684 open-end mutual funds totaling $11.6 trillion dollars in assets.

Open-end versus Closed-end Funds

   Closed-end mutual funds (<10% of mutual funds)
     A type of investment company that operates with a
      fixed number of shares outstanding
     Shares are issued by an investment company only
      when the fund is organized
     After all original shares are sold you can only
      purchase shares from another investor
        Bought and sold like stocks on the open market
        Incur brokerage commissions
         Closed-end investment companies are not as popular with
    individual investors as open-end investment companies. At the
     end of December 2011, there were only 634 closed-end mutual
                  funds holding only $239 billion dollars in assets.

Open-end versus Closed-end Funds

   Net Asset Value
      The underlying value of one share in a particular
        mutual fund
          Add up the value of the securities in the mutual fund
          Subtract any liabilities (normally close to zero)
          Divide by the number of shares

    Open-end mutual funds are sold at net asset value (with a sales
     load added to load funds). Since closed-end mutual funds are
     bought and sold on the open market, their price usually either
    reflects a premium or discount to the net asset value (usually a
     discount). They are very rarely priced at their net asset value.

Open-end versus Closed-end Funds

Net Asset Value =

   Value of the fund’s portfolio - Liabilities
       Number of shares outstanding

      Example: $10,050,000 - $50,000 = $10 NAV

  Offering price = NAV + sales commission
   Example: $10 + ($10 * 5%) = $10.50 Offering Price

Open-end versus Closed-end Funds

   Advantages / Disadvantages?
     Open-end investment company
       Always able to buy and sell – no market forces
       Very popular – wide range of choices
       Large purchases or redemptions can make
        management of the fund more difficult
          Mutual fund company can “close the fund” to new investors
     Closed-end investment company
       Must pay broker’s commission (like a stock)
       Must be bought/sold via the marketplace
       Often sold at premium or discount to NAV
       Easier to manage assets for investment advisors
                                Which would (or do) you prefer?

A New Type of Mutual Fund: ETFs
   Exchange-traded Funds
     An open-end mutual fund that trades on the
      exchanges like closed-end mutual funds
     There is no limit to the number of shares
          The mutual fund company issues shares as needed
     But the investor must purchase the fund using a
        brokerage account
          Incurring brokerage transaction fees (commissions)

 A recent entry to the industry, ETFs are becoming increasingly popular.
       At the end of 2011, there were 1,166 ETFs totaling $1,048 billion.
                        At the end of 2010, there 950 ETFs totaling $992 billion in assets.
 At the end of 2009, there were 820 ETFs totaling $777 billion. At the end of 2008, there
 were 743 totaling $531 billion. At the end of 2007, there were 629 totaling $608 billion.
                     And at the end of 2006, there were 359 totaling $423 billion dollars.
                                       Again, take note of the steep drop in value in 2008.

How are Mutual Funds Regulated?
   Investment Company Act of 1940
     Foundation of the modern mutual fund industry
     Defined “regulated investment company”
        a.k.a. “pass-through” investment vehicle
        Does not pay taxes on its investment income
          The shareholders pay the taxes
     To qualify, an investment company must…
        Hold almost all its assets as investments in stocks,
         bonds, and other traditional securities, and
          Very limited ability to use derivatives & other risky strategies
        Use no more than 5% of its assets when acquiring a
         particular security, and
        Create an organization with “checks & balances”


How are Mutual Funds Organized?
   The Mutual Fund
     A Corporation run by a Board of Directors
     Board of Directors voted in by Shareholders          (investors)
     Sponsored the fund’s creator
   Investment Advisor (a.k.a. Management Company)
     Portfolio Manager (sometimes a team or a committee)
     Research Analysts (usually focus on a specific industry)
   Distributors
     Distributes the shares to the public or to dealers
       Much the same role as an investment banker
          Mutual funds are technically continuous Initial Public
           Offerings – must have an annual prospectus & report

How are Mutual Funds Organized?

   Custodian
     The company that actually holds the securities
        Often a bank or trust company
   Transfer Agent
     Keeps track of purchase and redemption requests
      from shareholders
   Independent Public Accounting Firm
     Certifies the fund’s financial reports

     Why the large diversification of tasks and companies? Mutual
        funds are highly regulated in order to protect shareholders’
    investment from fraud and collapse. How often have you heard
        of a scandal at a mutual fund company? Until 2003, never.
     Wait a minute, Paiano! Did you just say,

“Mutual Fund Scandals?!”
   “You want me to invest in an industry that is
    plagued with scandal?!”
     Since 1940, the mutual fund industry has been
      regulated and escaped any hint of impropriety
     In 2003, some practices that were not quite illegal
      but obviously unethical were uncovered
        Only a handful of funds and people were affected
        Strong, Janus, Bank of America, Putnum, Alliance
     The vast majority of companies never engaged in
      any of the shenanigans
    Instead of losing $99,999 on a $100,000 account (example: Enron
              or WorldCom), investors lost $1 on a $100,000 account.

Annual Operating Expenses
   Management fees
     Charged yearly (.25%-2% average) based on a
      percentage of the fund’s asset value
     Paid to portfolio managers and analysts who
      make the investment decisions
   12b-1 fees
     Annual fee to defray advertising, servicing, and
      distribution costs of the fund – up to 1% per year
   Accounting and other expenses
   Trustee fee
     Only for retirement accounts – typically $10 to

Annual Operating Expenses

   Trading Costs
     Not disclosed in the annual prospectus
     So how does an investor know how much the
      trading costs are?
       You can ask the mutual fund or just look at the…
     Annual Turnover
        Measure of how much trading a mutual fund does
        Measured in percentage of the amount a portfolio
         “turns over” each year
          100% turnover, 50% turnover, etc.
          The higher the turnover, the higher the trading costs
          Also gives you an idea how long they hold investments
             100% turnover: They hold on average one year
             50% turnover: They hold on average two years

Load versus No-load Funds
   Load Fund
     A mutual fund that charges a commission when
      shares are bought
     Typically 3% to 5%
     Used to compensate the financial representative
       Along with the fund distributor
   No-load Fund
     A mutual fund that does not charge a commission
      when shares are bought
       Traditionally sold directly to shareholders
                       The endless debate: Should you purchase a
                                    Load Fund or No-load Fund?

Load versus No-load Funds

   Types of Load Funds
     Front-end Load – a.k.a. Class A
        Commission is paid when shares are purchased
        Normally have lower annual operating expenses
     Back-end Load – a.k.a. Class B
        Commission is paid when shares are redeemed
        Most back-end load funds have a Contingent
         Deferred Sales Charge (CDSC)
          The CDSC declines to zero over a period of 3 to 6 years
          5% first year, 4% second year, 3% third year, etc.
       Normally, the back-end load pay higher annual
        operating expenses (12b-1 fees) until the CDSC
        declines to zero
          Eventually, the Class B shares revert to Class A shares

Load versus No-load Funds

   Types of Load Funds (continued)
     No-load       Funds (Huh?) – a.k.a. Class C
       No front-end nor back-end commissions
          Except 1% back-end charge if redeemed within one year
        However, many Class C funds have higher annual
        operating expenses in perpetuity (or for a long time)
          There are those 12b-1 fees again
        Hence, they can wind up costing more than the
         Class A or Class B shares over time
        The SEC now says you can not call a mutual fund a
         “no-load” fund if the 12b-1 fee is greater than 0.25%
          So, Class C shares are now not allowed to be called “no-
           load” funds even though many in the industry still do

Load versus No-load Funds

   Types of No-load Funds
     Advisor No-load Funds – a.k.a. Class F, Class I
        Held in advisor’s “wrap account”
          a.k.a. “Management account,” “Wealth Management Account”
       Advisor charges 1% to 2% to “manage the account”
     “True” No-load Funds
        Mutual fund company deals directly with public
        May not have a 12b-1 fee greater than 0.25%
        These are the darlings of the popular media
          “Bypass the middleman! Who needs a financial advisor?”
       But that does not mean the overall fees are low
          Over time, a no-load fund can wind up costing you more
           than a load fund
          You must compare the annual operating expenses
Example of Shareholder Fees:                                 Fund of

 Transaction fees                   Class A Class B Class C Class F-1
 Maximum sales charge               5.75%    None    None       None
 Maximum sales charge on            None     None    None       None
 reinvested dividends
 Maximum deferred sales charge      None    5.00%   1.00%       None
 Redemption or exchange fees        None     None    None       None
 Annual Operating Expenses          Class A Class B Class C Class F-1
 Management Fees                    0.28%   0.28%   0.28%       0.28%
 Distribution and/or Service Fees   0.24%   1.00%   1.00%       0.25%
 (a.k.a. 12b-1)
 Other Expenses                     0.19%   0.18%   0.21%       0.15%
                           Total:   0.71%   1.46%   1.49%       0.68%
                                                    This is a load fund.
Example of Shareholder Fees:                               Large Cap
                                                          Growth Fund

 Transaction fees                   Class A Class B Class C Class F
 Maximum sales charge               4.25%   None     None      None
 Maximum sales charge on            None    None     None      None
 reinvested dividends
 Maximum deferred sales charge      None    4.00%    1.00%     None
 Redemption or exchange fees        None    None     None      None
 Annual Operating Expenses          Class A Class B Class C Class F
 Management Fees                    0.75%   0.75%    0.75%     0.75%
 Distribution and/or Service Fees   0.30%   1.00%    1.00%     0.00%
 (a.k.a. 12b-1)
 Other Expenses                     0.20%   0.43%    0.36%     0.32%
                           Total:   1.25%   2.18%    2.11%     1.07%
                                                    Another load fund.
Example of Shareholder Fees:                                       Mason
                                                                 Value Trust

 Transaction fees                   Class A   Class C      FI     Institutional
 Maximum sales charge               5.75%      None      None        None
 Maximum sales charge on             None      None      None        None
 reinvested dividends
 Maximum deferred sales charge       None     0.95%      None        None
 Redemption or exchange fees         None      None      None        None

 Annual Operating Expenses          Class A   Class C      FI     Institutional
 Management Fees                    0.67%     0.67%      0.67%       0.67%
 Distribution and/or Service Fees   0.25%     0.95%      0.25%       0.00%
 (a.k.a. 12b-1)
 Other Expenses                     0.09%     0.16%      0.18%       0.10%
                           Total:   1.01%     1.78%      1.10%       0.77%

  This is a very famous, now infamous, mutual fund. They just recently changed
   from “Primary Class” shares to “Class C” shares and added Class A shares.

Example of Shareholder Fees:
                                                                500 Index

  Transaction fees
                                             This is an index fund. This
  Maximum sales charge              None
                                           fund does no research. They
  Maximum sales charge on           None simply buy all the 500 stocks
  reinvested dividends                       in the S&P 500 Index. The
  Maximum deferred sales charge None            term for this is “passive
  Redemption or exchange fees       None   management.” (More later)
                                                 Index funds are usually
  Annual Operating Expenses        Class A “true” no-load mutual fund
  Management Fees                  0.14% and usually (but not always)
                                                     have very low fees.
  Distribution and/or Service Fees   
  (a.k.a. 12b-1)
                                               There is a $20 annual fee if
  Other Expenses                    0.03%          your account value is less
                           Total:   0.17%                     than $10,000.

Example of Shareholder Fees:
                                                                Spartan 500
                                                                Index Fund

  Transaction fees                                Vanguard pioneered low
  Maximum sales charge                None       fee mutual funds and was
  Maximum sales charge on             None     able to overtake Fidelity as
  reinvested dividends                         the number #1 mutual fund
  Maximum deferred sales charge       None       company for a short time.
  Redemption or exchange fees         None           Fidelity responded by
                                               eliminating all sales loads,
  Annual Operating Expenses          Class A      creating their own index
                                                 funds, and lowering their
  Management Fees                    0.025%
                                                     fees below Vanguard.
  Distribution and/or Service Fees     
  (a.k.a. 12b-1)                                   Like the Vanguard fund,
  Other Expenses                     0.07%           there is a “low balance”
                                                     annual fee of $10 if your
                            Total: 0.095%           account is below $10,000.

Examples of Dollar Costs:
                                                           Fund of

 Hypothetical $10,000 Investment     1       3       5        10
 with 5% Return                     Year   Years   Years     Years
 Class A                            $643   $789     $947    $1,407
 Class B (assuming no redemption)    149    462      797      1,543
 Class C (assuming no redemption)    152    471      813      1,779
 Class F-1 (excludes advisor fee)     69    218      379        847

       Although it looks as though the F shares are the best deal,
       this does not include the advisor’s annual fee. Adding the
      advisor’s typical fee of 1% to 2% per year would easily add
        an additional $1,200 to $2,400 to the total cost. Over the
                                 long term, which is the best deal?

Examples of Dollar Costs:
                                                               Value Trust

 Hypothetical $10,000 Investment        1         3        5         10
 with 5% Return                        Year     Years    Years      Years
 Class A                               $672     $878    $1,101     $1,741
 Class C (formerly Primary Class)       181      561       965      2,096
 Financial Intermediary Class            112     350       607      1,341
 Institutional Class                      79     246       428         955

   The class C shares of this “no load” fund wind up costing more than the
      class A shares! Again, the Financial Intermediary Class seems to be a
            better deal but it does not include the advisor’s annual fee. The
Institutional Class looks great. How can I get them? Well, for starters, are
    you a large pension fund, university endowment, or tax-exempt charity?
               Oh, and by the way, do you have at least $1 million to invest?

Examples of Dollar Costs:
                                                          500 Index

 Hypothetical $10,000 Investment    1       3       5          10
 with 5% Return                    Year   Years   Years       Years
 Investor Class                     $17    $55      $96        $217
 Admiral Class                        5     16       28           64

 The fees for passively-managed index funds will almost always be
 less than actively-managed funds. The Admiral Class shares used
    to be available with a minimum of only $100,000. Any takers?
        (In the fall of 2010, they lowered the minimum to $10,000.)
 Do you remember the exchange-traded funds (ETFs)? They often
     have fees lower than the index funds! The Vanguard ETF that
 tracks the total U. S. stock market has an expense ratio of 0.05%.

Breakpoint Sales Reductions:
                                                                  Fund of

       Investment (either purchased or accumulated)   Sales Charge
       Less than $25,000                                 5.75%
       $25,000 but less than $50,000                     5.00%
       $50,000 but less than $100,000                    4.50%
       $100,000 but less than $250,000                   3.50%
       $250,000 but less than $500,000                   2.50%
       $500,000 but less than $750,000                   2.00%
       $750,000 but less than $1,000,000                 1.50%
       $1,000,000 or more                                 None

       Class A shares typically qualify for a sales reduction if you invest a
  larger amount or as your investment grows. Some brokers fail to inform
         their clients of this feature. Instead, as the client approaches the
      breakpoint, the broker will advise them to start another fund. Why?

CDSC Reduction over Time:
                                                             Fund of

    Contingent Deferred Sales Charge (CDSC) on Class B Shares
    Year of Redemption         Contingent Deferred Sales Charge
              1                             5.0%
              2                             4.0%
              3                             4.0%
              4                             3.0%
              5                             2.0%
              6                             1.0%
             7+                             0.0%

  The back-end sales charge on Class B shares typically is reduced over
   time until it is eliminated. However, as we noted, the Class B shares
                                        usually pay more in annual fees.

10-Year Rates of Return:
                                                                          So, Which
                                                                          One Would
                                          as of December 31, 2012         You Pick?

                                                             10-Year       Growth of
                                                             Return        $10,000

A   Growth Fund of America, Class A                           7.60%*         $20,792
B   Alliance Large Cap Growth Fund, Class A                   7.29%*         $20,211
C   Legg Mason Value Trust, Class C          Primary Class      2.22%        $12,455

D   Vanguard Index 500 Fund                                     6.99%        $19,644
    Standard & Poor’s 500 Index                                 7.10%        $19,849

      Fees are important, but they certainly do not tell you the whole
       story. When comparing mutual funds, you must look at many
             attributes, not the least of which are the rates of return,
                               preferably over longer periods of time.
       *8.24% and 7.75%, respectively, without sales charge (a.k.a. NAV, net asset value)

Mutual Funds Fees: What are __?
      These shares do not have an up-front sales
      load. Instead, they assess a decreasing
      back-end load if you withdraw your money
      within 6 years. The annual operating
      expense is higher (courtesy of the 12b-1 fees).
 A.   A shares
 B.   B shares
 C.   C shares
 D.   F or I shares
      The correct answer is (B). They normally eventually become
                                       A shares after 6 to 8 years.

Mutual Funds Fees: What are __?
      These shares do not have an up-front fee and
      only a 1% back-end fee if redeemed within one
      year. The advisor called them “no-load” but
      you notice that their annual operating expense
      is higher than other share classes (again, courtesy
      of those ubiquitous 12b-1 fees).
 A.   A shares
 B.   B shares
 C.   C shares
 D.   F or I shares
      The correct answer is (C). They sometimes revert to A or F
                                        shares after many years.

Mutual Funds Fees: What are __?
      Your financial advisor tells you that these
      shares have no sales fees and a very low
      annual operating expense. She mumbles
      something about “wealth management.”
      These shares are:
 A.   A shares
 B.   B shares
 C.   C shares
 D.   F or I shares
 The correct answer is (D). She also did her best not to explain
 that her brokerage firm will charge you an extra 2% each year.

Types of Mutual Funds
   Aggressive Growth Funds
     Highly speculative mutual funds that seek large
      profits from capital gains
       Dey Iz Rollin’ De’ Dice!
   Growth Funds
     Mutual funds whose primary goals are capital gains
      and long-term growth
       Typically invest in high-growth companies

           Some fund companies now have a category or two more
         speculative than Aggressive Growth. They are sometimes
    called Ultra Funds or Momentum Funds. (Example: Janus 20)
                           What do you think about this strategy?

Types of Mutual Funds                         (continued)

   Capital Appreciation Funds
     Mutual funds that seek long-term growth of capital
     How does it differ from a growth fund?
       Most growth funds have a provision that states they
        will invest primarily in growth stocks, usually staying
        between 80% & 100% invested in the market
     Capital Appreciation Funds can often invest in
      anything they like and anywhere they like
        In general, they tend to be as risky as growth and
        aggressive growth funds (although not always)

                    The well-known Fidelity Magellan Fund is a
                                    Capital Appreciation Fund

Types of Mutual Funds                       (continued)

   Growth-and-Income Funds
     Mutual funds that seek both long-term growth and
      current income, with primary emphasis on capital
       Sometimes own bonds to augment the income
       Sometimes referred to as “Blend” (of Growth & Value)
   Value Funds
     Mutual funds that seek stocks that are undervalued
      in the market by investing in shares that have low
      P/E multiples and high dividend yields
       Often look for companies out-of-favor with investors
                Some folks lump growth-and-income funds and
                                        value funds together

Types of Mutual Funds                            (continued)

   Equity-Income Funds
      Mutual funds that emphasize current income and
       capital preservation by investing primarily in high-
       yielding, income-producing common stocks
         Railroads, Foods, Utilities, REITs, etc.
      They will also invest in bonds to generate income
       when the investment advisor believes that stock
       prices have risen to levels that threaten
       preservation of capital
       Many Equity-Income Funds did very well during the 2000 to
    2002 bear market after lagging the market badly during the late
     1990’s bull market. Every type of fund was clobbered in 2008.

Types of Mutual Funds                          (continued)

   More Stock Fund Classifications
     Large Cap – largest companies                 Which do you
     Mid Cap – medium-sized companies                think is the
       Small Cap – smallest companies
       Domestic – companies based in U.S.      Which do you
       Global – based anywhere in globe           think is the
       International – based outside U.S.            riskiest?
       Regional – Japan, Far East, Latin America, etc.
       Emerging Markets – India, Mexico, Brazil, Russia,
      Philippines, China, Turkey, etc.
     Sector – energy, technology, health care, etc.
     Market Timing – dumb

Types of Mutual Funds                                (continued)

   Bond Funds – a.k.a. Fixed-income Funds
     Mutual funds that invest in various kinds and
      grades of bonds, with income as the primary
     High-Yield Bond Funds – a.k.a. Junk Bond Funds
       Are often more correlated with stocks than bonds
     Corporate Bond Funds
       Convertible Bond Funds
     Municipal and Insured Municipal Bond Funds
       Popular with high net worth individuals
       Income is free from Federal taxes
       State-specific municipal bond funds
          Income is free from state taxes as well

Types of Mutual Funds                           (continued)

   Bond Funds (continued)
     U.S. Backed Bonds (Fannie Mae, etc.)
        a.k.a. Mortgage-backed Bond Funds
     Government Bond Funds – a.k.a. Treasury Bond
      Funds, Government Securities Funds
        Income is free from state and local taxes

     Long-term Bond Funds                   Which do you think
     Intermediate-term Bond Funds               is the riskiest?
     Short-term Bond Funds
     Global and International Bond Funds

Types of Mutual Funds                          (continued)

   Balanced Funds
     Mutual funds whose objective is to generate a
      balanced return of both current income and long-
      term capital gains
     Invest in both stocks and bonds
     Normally 60% stocks and 40% bonds
       But allocation can change as the investment
        environment changes

     The prospectus of the American Balanced Fund states that the
    fund is “managed as the complete U. S. investment program of
    a prudent investor.” They can never be more than 75% stocks,
                  25% bonds or less than 50% stocks, 50% bonds.

Types of Mutual Funds                            (continued)

   Asset Allocation Funds
     Mutual funds that spread investors’ money across
      stocks, bonds, and money market securities
     Very similar to Balanced Funds
     However, the investment advisor often more
      diligently tries to “fine-tune” the allocation as
      market conditions change
        Whereas a Balanced Fund usually stays around 60%
         stocks / 40% bonds,
        An Asset-Allocation Fund might try to move money
         into cash when they thought the market might fall
      For all their hype, the returns of many Asset Allocation Funds
      are very close to Balanced Funds. Some trail Balanced Funds
               considerably because they “timed the market” badly.

Types of Mutual Funds                            (continued)

   Money Market Mutual Funds (review)
     Mutual funds that invest in short-term money
      market instruments
        Much the same as money market accounts at banks
         and credit unions EXCEPT money market mutual
         funds are not guaranteed
        General Purpose – Treasury bills, commercial paper
        Government Securities – Only Treasury bills
        Tax-exempt – very short-term municipal securities
          They are essentially as safe as guaranteed money market
       accounts since they invest in exactly the same securities but
         they are not guaranteed! (Did we already mention that?)
                                               “Breaking the Buck”

Types of Mutual Funds                           (continued)

   Mutual Funds of Mutual Funds
     a.k.a. Lifestyle Funds, Target-Date Funds
     Choose the fund that matches your time horizon …
        College 2020, Retirement 2035, etc.
     The company will populate the mutual fund with
      other mutual funds to match the time horizon
       Often from the same company’s mutual fund choices
     As the time horizon shortens, the mutual fund will
      change the mix of mutual funds
     Some are “Target-Risk” Funds
       Choose your risk tolerance & they choose the funds

         “A mutual fund of mutual funds? You are kidding, right?”
        No. These are very popular now because of retirement plans

Types of Mutual Funds                                (continued)

   Specialty Funds
     Hedge Funds
       Traditionally only open to “sophisticated investors”
           But now available to those with as little as $5,000 to $10,000
         No regulatory oversight – have become a major force
         1% to 2% operating expense; take 20% of the profits
       “Bear” Funds
       Precious Metals / Hard Assets Funds
       REIT Funds
       Boutique / Exotic Funds
         StockCar Stocks Fund
         Pauze Tombstone Fund
         The Chicken Little Growth Fund        (I am not making this up!)

                        The choices are endless. So are the fees…

Types of Mutual Funds                                (continued)

   Index Funds – a.k.a. Passively-managed
     Mutual funds that buy and hold a portfolio of stocks
      or bonds equivalent to those in a specific market
        No “active management” performed – no research
          The mutual fund simply buys all the stocks in the S&P 500,
           Dow Jones Industrial Average, Russell 2000, etc.
        Why?
          Can offer much lower annual fees (no research)
          Many actively-managed mutual funds do not beat the market
        Because of the annual fee, an index fund can not
        actually match the market’s performance, but it
        should come very close (providing the annual fee is not excessive)
          Whereas, an actively-managed fund could substantially out
           perform or under perform the market index

Types of Mutual Funds                               (continued)

   Index Funds (continued)
      The rationale for index funds came from research
        done in the early 1970’s that statistically showed
        that many of the actively-managed funds did not
        beat the market
          “A monkey throwing darts at a dartboard…”
      However, many actively-managed funds do beat
       their respective indexes over time
      Look for a fund family where most all funds have
       consistently beaten their indexes over decades!
          (Psst! There are only a few major companies)

    In the late ’90’s, index funds became a victim of their own success.

Types of Mutual Funds                           (continued)

   Index Funds (continued)
     Standard & Poor’s 500 (a.k.a. S&P 500)
     Dow Jones Industrial Average (a.k.a. the Dow)
     Dow Jones U.S. Total Stock Market Index
        nee Dow Jones Wilshire 5000, nee Wilshire 5000
        a.k.a. Total Market Index
     NASDAQ Composite & NASDAQ 100
     MSCI World (Global) & EAFE Index (International)
     Countless other index funds available now
                Index funds are the current “perfect investment.”
         For the failsafe superlative treatment, visit
                   What, if any, are the downsides to index funds?

Types of Mutual Funds                      (continued)

   Index Funds (continued)
     Indexes sometimes become skewed toward a
      particular sector of the economy or region of the
      world (more about this phenomenon later)

           MSCI EAFE 12/31/1989        S&P 500 3/31/2000

            Japan, 59.8%                Info Tech, 33.3%
            P/E: 51.9                   P/E: 59.2

                                         All else, 66.7%
            All else, 40.2%              P/E: 19.3
            P/E: 13.0

Types of Mutual Funds                       (continued)

   Exchange-Traded Funds – a.k.a. ETFs
     An open-end mutual fund that trades as a listed
      security on a stock exchange
       Trades like a stock as does a closed-end fund
       But there is no limit on the number of shares
     Becoming very popular because they can be
      bought and sold throughout the day like stocks
       Unlike open-end mutual funds, which always trade
        at the end-of-day net asset value
     Most all ETFs are passively-managed index funds
       But there are also some actively-managed ETFs

And they have cool names like “Spider,” “Diamond,” and “Cube”

Types of Mutual Funds                                (continued)

   Socially Responsible Funds
     Mutual funds that actively and directly incorporate
      ethics and morality into the investment decisions
       Started out with some funds refusing to invest in
        companies that sold alcohol or tobacco
       Moved to companies that pollute, build weapons or
        nuclear power plants, destroy the rain forests, etc.
       And then to companies that exploit labor
          It is surprising that there any companies left to invest in …

            Silliness aside, many Socially Responsible Funds have
                                 done quite well for their investors

Types of Mutual Funds                             (continued)

   Socially Irresponsible Funds (???)
     Possibly as a backlash to socially responsible
      funds (and their perceived political overtones)
     There is a mutual fund called The Vice Fund
        Yep! You guessed it!
        It invests in tobacco and alcohol …
          (The manager says he simply loves Philip Morris!)
        And all the other corporate nasties you can think of
          Gambling, Defense firms

And although it is still a very small fund with high annual fees, it
        has done very well for its investors (

Types of Mutual Funds                               (continued)

                        Value         Blend        Growth




      Morningstar, a company that analyzes mutual funds, designed the
 “style box” to help investors identify investment alternatives. They say
              they are fabulous. No one I know uses them; neither do I.
      Now they have “ownership zones.” They say they are even better.

    Fund Families
 A family of funds exists when one investment
  company manages a group of mutual funds
 Funds in the family vary in their objectives
 You can move your money from one fund to
  another within a fund family
     Almost always with no charge
     But, if the fund is in a taxable account, you could
      generate a taxable transaction
     Recently, fees are being charged for “excessive”
      transfers within the fund family
       Done to discourage “market timing” by investors

                Forbes sez, “Choose a Family, Not a Fund”

Fund Families: Top Ten Families
1.  Vanguard Group       Examples: Offerings from the top
                                           three families
2.  Fidelity Investments
3. American Funds (CR&M)
4. PIMCO Funds
5. J. P. Morgan Chase
6. Franklin Templeton Investments
7. BlackRock Funds
8. Federated Investors
9. T. Rowe Price
10. Bank of New York / Dreyfus Corporation

Source: Investment Company Institute, Dec 2011

Mutual Fund Investor Services
   Automatic Investment Plans
     Mutual fund service that allows shareholders to
      automatically send fixed amounts of money from
      their paychecks or bank accounts into the fund
     a.k.a. Dollar-Cost Averaging (more later)
     “Pay yourself first!”

    In my humble opinion, this is the absolute best way to invest in
      a mutual fund. You do not worry about whether or not it is a
     good time to invest. Every month is a good time to invest $50
        that comes right out of your paycheck or checking account.
     P.S. It is practically the only way most people will ever invest!

Mutual Fund Investor Services                    (continued)

   Automatic Reinvestment Plan
     Mutual fund service that enables shareholders to
      automatically buy additional shares in the fund
      through the reinvestment of dividends, interest,
      and capital gains

          Automatic Reinvestment Plans allow an investor to earn
      fully compounded rates of return. Unless an investor needs
         the income, it is always a good idea to reinvest dividends
                  and capital gains received from a mutual fund.

Mutual Fund Investor Services              (continued)

   Systematic Withdrawal Plan
     Mutual fund service that enables shareholders to
      automatically receive a predetermined amount of
      money monthly or quarterly
        Sometimes annually
     Normally electronically transferred directly to your
      checking account
   Conversion Privilege – a.k.a. Exchange Privilege
     Allows shareholders to move money from one fund
      to another within the same family of funds
     May trigger tax consequences if not in a retirement

Mutual Fund Transactions
   Purchase options
     Closed-end & ETFs through the stock exchange
     Open-end
       Through a broker
       Directly from the investment company
       Best way is auto-contributions (payroll, checking)
   Sell options
     Closed-end & ETFs through the stock exchange
     Open-end
       Through a broker or through the mutual fund
       Best way is auto-withdrawals (into your checking)

Taxes and Mutual Funds
   Two types of taxes for Regular Accounts
     Income dividends
        Taxed as income (20% max, 15% typical, 5% min)
     Capital gains distributions
        Taxed as capital gains (20% max, 15%, 5% min)
     Reinvested dividends and capital gains are still
      taxable transactions
        Save your year-end statements
        Congress may change this someday (doubtful!)
          Unrealized capital gains (a.k.a. paper profits) would not be
           taxed until you sell your mutual fund shares (forget it!)
   Tax-deferred Retirement Accounts (401(k), etc.)
     Pay no taxes until retirement
     All proceeds taxed as income (except Roth tax-free)

Sources of Mutual Fund Information
    Mutual Fund Prospectus
      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 about dividends, distributions & taxes
      Information about the fund’s management
      No one reads them!
        Unless they have taken BUS-123
           It was not that hard, was it?

    Mutual Fund Annual Report
      Performance, investments, assets and liabilities

Sources of Mutual Fund Information

    Financial publications
      Morningstar, Lipper, etc.
      Business Week, Forbes, Kiplinger's Personal
       Finance, and Money are sources of information
       on mutual funds
      Mutual fund surveys usually include:
         Fund’s overall rating compared to other funds
         Fund’s rating compared to funds in the same
         Fund size, sales charge and expense ratio
         Risk of loss factor and toll-free number
         History for past three, five, and ten years

Sources of Mutual Fund Information

    Financial web sites
    Mutual fund companies’ Internet sites
                 Hurray! The mutual
               fund web sites are again
             promoting education.
    Investment Company Institute web site

“So, How Do I Pick a Mutual Fund?”
     Pick a Mutual Fund that…
       Invests in high-quality stocks or bonds
       Is well-diversified across several industries and
        sectors of the economy
       Has a long-term perspective and a manager or
        (better yet) a management team with many years
        of experience
         Avoid companies that “shuffle” their managers
          every few years (which is virtually all of them!)
       Has been around for decades and performed
        consistently well in both good and bad markets

A Sample Stock Mutual Fund
 Is 79 years “long-term” enough for you?
 6%, 8%, 9%, 10%? How about almost 12%?
 “But stocks are very risky”
     Short-term, Yes. Long-term, No!
   “But now is not a good time to invest”
     “Excuse me, when is it ever a good time to invest?”
     Okay, so what if you had invested on the worst day
      of the year for the past 20 years? How did you do?
   “But what about market downturns?”
     Keep a long-term perspective, and
     Dollar Cost Average…

Dollar-Cost Averaging
 A system of buying an investment at regular
  intervals with a fixed dollar amount
 With Dollar-Cost Averaging, there is always
  “Good News”
     “The market is up! Good News!”
        Your account is worth more
     “The market is down! Good News!”
        Next month, you will get more shares at a
         lower price when the $50 or $100 comes out of
         your paycheck or checking account
     Your average cost-per-share should be
     lower than your average price-per-share

   Most mutual fund companies have a system for
    running “hypotheticals”
       a.k.a. “Illustrations” “Hypothetical illustrations”
       Examples of returns of investments
       Lump sum principals, or
       Streams of investments
         a.k.a. Dollar-Cost Averaging
     Or combinations of both
     Must be approved by SEC and FINRA
       And contain disclaimers about past versus future
                                    Let’s run some hypotheticals!

And That Ain’t the Only One!

                  As of December 31, 2012

Bottom Line on Mutual Funds
   Choose a fund family and stick with them
     “Most mutual fund investors do worse than the
      mutual funds they invest in”
     Re-evaluate them periodically (once or twice a year?)
       But make changes judiciously and sparingly
       As you approach retirement, migrate from stock funds
        to bond funds
          But do not give up stocks entirely (ICA illustration)
     Dollar-Cost Average
       $50 a month, $100 a month, whatever is affordable…
       For the most part, Forget About Them!
              Do not be one of the mutual fund investors that does
                                   worse than your mutual funds!

 Mutual Funds
 Chapter Sections:
 Advantages and Drawbacks of Mutual Fund Investing
 Investment Companies and Fund Types
 Mutual Funds Operations
 Mutual Funds Costs and Fees
 Short-Term Funds
 Long-Term Funds
 Mutual Fund Performance
 Closed-End Funds, Exchange Traded Funds, and Hedge Funds

                     Next week: Chapter 5, The Stock Market

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