invest by jizhen1947

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									                                 Investing Basics


This information is being provided as a service for NTM members to help them achieve
their investment goals. The materials and web-links provided will give you access to in-
formation concerning investing, taxes and retirement programs. We make no express or
implied guarantees. All final conclusions depend upon the unique circumstances of each
individual investor. As always with investment material, past performance is no guaran-
tee of future results. If you desire expert advice, we would recommend contacting a li-
censed financial advisor or licensed tax advisor before making any final conclusions.
                                           The Power of Compounding

At the heart of sound investment theory is a simple mathematical formula known as the
Power of Compounding. If you put your money in an investment with a given return —
and then reinvest those earnings as you receive them — the snowball effect can be as-
tounding over the long term. This is particularly true in retirement accounts, where your
principal (initial investment) is allowed to grow for years tax-deferred.

Suppose you have $10,000 in your bank account and decide to put it into an investment
with an 8% annual return. For the first year, you earn $800 on your initial investment
(called “the principal”), which gives you a total of $10,800. If you leave those earnings
alone, rather than spend them, then the second year would deliver another $864, or 8% on
both the original $10,000 and the $800 gain. Your two-year total: $11,664. The longer
you keep reinvesting those earnings, the more dramatically your nest egg will grow.

                    T o ta l

                                         1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

As you can see, compounding produces modest — but steady — gains over the first few
years. But the longer you leave your money in, the faster it begins to grow. By year 20 in
our example, your money would have quadrupled to more than $46,000.

Of course, the power of compounding also works for cash accounts such as money-
market funds which have lower interest rates. If you adjust the interest rate downward to
4% (which would be a very good rate of return for a money-market fund in 2004), you’ll
see what you’re giving up: Your 20-year return on that $10,000 drops to around $22,000.
Now increase the interest rate up to 10%. At that rate, your $10,000 investment balloons
to $67,275. The average historical annual rate of return for the stock market is around

The lesson is this: The longer you leave your money invested and the higher the interest
rate, the faster it will grow. That’s why stocks or mutual funds are the best long-term in-
vestment value. Of course, the stock market is also much more volatile than a savings
account. But given enough time, the risk of loss is diminished by the general upward
momentum of the economy.
                                   Time Lessens Risk

Although the stock market has ups and downs it has consistently realized an annual
growth rate of around 11% from 1926 through 2000.

While the line zigzags up and down from year to year, the overall trend is upward. Con-
sider this: If in 1929 you invested $1,000 in large-cap stocks, you’d be sitting on roughly
$1 million today (according to data from the Center for Research in Securities Prices).

Those long-term gains are all the more remarkable when you consider that the 73 years in
question (1929 to 2002) included the Great Depression, the market doldrums of the early
1970s, the two market crashes that punctuated the 1980s, as well as the recent bear mar-
ket (from 2000 to 2002). The 10-year periods with positive returns far outnumber those in
which investors lost money.

                             Isn’t investing just gambling?

The financial markets are often compared to a casino. You know, put some money down
on Intel and you might as well be playing blackjack. If that’s your impression, and it’s
keeping you from investing, consider this: If investing is nothing more than organized
gambling, then it’s one of the rare kinds where the odds are stacked in your favor.

History has shown that with enough time and a little discipline, you are all but guaranteed
to make a nice return on your investment. You merely need patience and a willingness to
put your savings to work in a balanced portfolio of securities tailored to your age and cir-

To see why, you have to understand how investing works. It’s not about throwing all
your money into the “next Microsoft,” hoping to make a killing. And it has nothing to do
with getting a stock tip from your brother-in-law and clicking over to E*Trade to buy as
many shares as you can get.

Investing isn’t gambling or speculation. It’s taking reasonable risks to earn steady re-
wards. As we’ll see, it works because investing allows you to participate in the consistent
growth of the world’s economy, which hardly follows a straight line, but does trend up-
ward over time. It’s also true that the longer you stay invested, the more dramatic your
money will grow. This neat trick — called the Power of Compound Interest — is a
mathematical certainty, something you can bank on.

                     There is some risk involved with investing,
               but when it comes right down to it life itself is a gamble!

You take a chance anytime you drive or fly, but that doesn’t stop us from traveling!

Have you read the warning labels lately on popular medications? Here’s one from a cold

       Warning: This drug may cause a severe allergic reaction (difficulty breathing;
       closing of the throat; swelling of the lips, tongue, or face; or hives); liver prob-
       lems (yellowing of the skin or eyes, abdominal pain); blood problems (easy or
       unusual bleeding or bruising); or low blood sugar (fatigue, increased hunger or
       thirst, dizziness or fainting). Other, less serious side effects are more likely to oc-
       cur including: dryness of the eyes, nose, or mouth; drowsiness or dizziness;
       blurred vision; difficulty urinating; or excitation in children.

It almost seems like the cure is worse than the sickness. Why would anyone risk taking a
cold medicine?

The Scriptures teach wise planning:

                                The Parable of the Talents
                                 Matthew 25:14-30 (NLT)

Again, the Kingdom of Heaven can be illustrated by the story of a man going on a trip.
He called together his servants and gave them money to invest for him while he was
gone. He gave five bags of gold to one, two bags of gold to another, and one bag of gold
to the last — dividing it in proportion to their abilities — and then left on his trip. The
servant who received the five bags of gold began immediately to invest the money and
soon doubled it. The servant with two bags of gold also went right to work and doubled
the money. But the servant who received the one bag of gold dug a hole in the ground
and hid the master’s money for safekeeping. “After a long time their master returned
from his trip and called them to give an account of how they had used his money. The
servant to whom he had entrusted the five bags of gold said, ‘Sir, you gave me five bags
of gold to invest, and I have doubled the amount.’ The master was full of praise. ‘Well
done, my good and faithful servant. You have been faithful in handling this small
amount, so now I will give you many more responsibilities. Let’s celebrate together!’
“Next came the servant who had received the two bags of gold, with the report, ‘Sir, you
gave me two bags of gold to invest, and I have doubled the amount.’ The master said,
‘Well done, my good and faithful servant. You have been faithful in handling this small
amount, so now I will give you many more responsibilities. Let’s celebrate together!’
“Then the servant with the one bag of gold came and said, ‘Sir, I know you are a hard
man, harvesting crops you didn’t plant and gathering crops you didn’t cultivate. I was
afraid I would lose your money, so I hid it in the earth and here it is.’ “But the master re-
plied, ‘You wicked and lazy servant! You think I’m a hard man, do you, harvesting crops
I didn’t plant and gathering crops I didn’t cultivate? Well, you should at least have put
my money into the bank so I could have some interest. Take the money from this servant
and give it to the one with the ten bags of gold. To those who use well what they are
given, even more will be given, and they will have an abundance. But from those who are
unfaithful, even what little they have will be taken away. Now throw this useless servant
into outer darkness, where there will be weeping and gnashing of teeth.’

Note: The unfaithful servant allowed fear to govern his decision. He replied, “I was
afraid I would lose your money, so I hid it in the earth and here it is.”

                                      Ecclesiastes 11:4

He who observes the wind will not sow, and he who regards the clouds will not reap.

                                       Proverbs 20:4

The lazy man will not plow because of winter; He will beg during harvest and have noth-

                                       Proverbs 22:13

The lazy man says, “There is a lion outside! I shall be slain in the streets!”

                                      Risk vs. Reward

Risk is a fact of life for any investor. Stocks plunge. Companies go bankrupt. The stock
market goes through periods of decline. There’s even risk in doing nothing: Thanks to
inflation, $100 left moldering in the bank earning no interest will be worth about $75 in
10 years. To earn rewards, you have to assume a certain amount of risk. The higher the
risk you’re willing to assume, then the higher the reward you will achieve. On the other
hand, the lower the risk you assume, the lower the reward. If you minimize your exposure
to the perils of investing, then you have to accept lower returns.

During the late 1990’s, most investors thought they had a great tolerance for volatility
because the market was booming. But around the year 2000 the U.S. economy took a
downward turn. After three years of a bear market (where stock prices decline for a pro-
longed period of time), some of those same investors decided that they have no risk toler-
ance, and today they are missing out on the market’s gains. How much of a tolerance for
risk do you have? For most of us, the right place is somewhere in the middle. Recogniz-
ing that dangers do exist, you simply need to follow a few easy strategies in order to
minimize the risks.
Before investing a person needs to determine their tolerance for risk. However in doing
so, you need to realize that “risk tolerance” has more to do with time than temperament.
The more time you have to make up for short-term losses, the more aggressive you can
be with your investments. A younger person investing for retirement should have a
greater tolerance for risk than someone in their 60’s. The easiest way to reduce the risk of
investing — and improve your reward — is to increase the time you hang on to your in-
vestments. Of course, the opposite is also true: If you’re saving for a short-term goal, then
it’s best not to bet the ranch on a fund that has substantial swings both up and down.

                                  Minimizing the Risks

Three easy strategies will help protect your investments and minimize your risk:

   •   Diversification
   •   Dollar Cost Averaging
   •   Asset Allocation


The single best way to protect yourself from a meltdown in one stock or industry is to
spread your risk across several different investments. The more diversified your portfolio
is, the less any one investment can hurt you by blowing up. The old saying, “don’t put all
your eggs in one basket” aptly applies to investing. While it might be tempting to pile all
your money in dynamic performers, keep in mind that they can head south, too. The les-
son is: Spread your investments around.

Dollar-cost averaging

This strategy is to invest fixed amounts of money at regular intervals, regardless of the
markets’ movements. Dollar-cost averaging is another form of diversification — only
instead of spreading your money over a bunch of different investments, it diversifies your
investments over time. As a result, when the price is lower, more shares of the security
are purchased than when prices are higher. $300 invested into the same fund every month
will get you a lot more shares when the fund is down than when it’s flying high.

Many stock investors try to “time the market” so that they will buy stocks at a low price
and sell at a high price. That takes a lot of research and a fair amount of luck. Dollar cost
averaging eliminates those headaches. Dollar cost averaging allows you to buy more
shares when the fund is down and fewer shares when it is up. Here’s how it works: Sup-
pose you decide to put $300 a month into a mutual fund that invests in the stocks of large
companies. Your mutual fund company can set up an automatic investment account for
you — a 403 (b) — and the money is pulled straight from your Sanford account on the
same day each month. If a share of the fund costs $50 in October, your $300 will buy six
shares. If the price rises to $75 in November, you buy four shares. If the price drops to
$25 in December you buy 12 shares. The idea is that your money buys more shares when
the price is cheap and fewer when the price is high.
Asset allocation

Asset allocation is yet another way to diversify. It takes advantage of the fact that when it
comes to risk and reward, financial categories like stocks, bonds and money-market ac-
counts all behave quite differently.

Stocks, for instance, offer the highest returns among those three “asset classes,” but they
also carry the highest risk of losses. Bonds aren’t as lucrative, but they offer far more sta-
bility than stocks. Money-market returns are puny, but you’ll never lose your initial in-
vestment. An asset-allocation strategy looks at your particular goals and circumstances
and determines what asset mix gives you the optimal blend of risk and reward.

Here’s an example. Say your goal is retirement. When you’re young — in your 20s or
30s — and have time to make up for short-term market losses, an asset-allocation scheme
would put you heavily into stock funds. You might even spice it up with a mix of large-
cap stock funds, small-cap stock fund and international stock funds to diversify your port-

As you move into your late 30s and early 40s, however, you’d probably want to give your
portfolio some stability and income. Maybe you’d shift to a 75/25 blend — still favoring
stock funds, but also include safer bond funds. The closer you got to retirement age, the
more you would ratchet up bond funds and taper off stock funds. And in your last few
years, when you simply could not afford big market losses, your portfolio would be
heavy on short-term bonds or money-market funds — the least risky of all investments.

There are a number of on-line tools to help you determine your asset allocation.

                                       Time vs. Risk

During the 1990’s investors made significant gains from stocks and mutual funds. This is
called a “bull market.” But in the year 2000 our country headed into a recession and the
market began a downward trend which is called a “bear market.” After a three year de-
cline, it’s certainly understandable that some investors just could not get over their fear of
losing money in the market. They seem to view stocks as an anxious game of Russian
roulette: The longer they stay in, the greater their chance of experiencing more losses. In
fact, history shows that the opposite is true. The easiest way to reduce the risk of invest-
ing — and improve gains — is to increase the time you hang on to your investments.
The graphs below uses historical data from 1950 through 2002 to compare investment
returns over different lengths of time for small-cap stocks (high risk), large-caps (moder-
ate risk), long-term bonds (low risk) and T-bills (very low risk).

The first graph starts out by showing results for investments held over one-year periods.
There’s no doubt about it: Over such short intervals, small-cap funds are definitely the
riskiest bet. Sure, you could’ve doubled your money if you’d invested during the year
starting July 1982 — the best 12 months of the bunch. But if you’d invested during the
year starting October 1973, near the beginning of the OPEC oil embargo, you would’ve
faced a disastrous 41% loss. Compare that with 20-year Treasury bonds — during their
worst year, beginning April 1979, they were down only about 13%.

But what about investing for more than a year? Even investing for two years instead of
one cuts your risk significantly. As the length of time increases, the volatility of invest-
ments decreases sharply.
Adjusting for inflation, the best 20-year gain a portfolio of long-term Treasury bonds
could muster was 7.9% a year (October 1981 to October 2001). And bondholders who
invested from 1961 to 1981 actually lost money.

Meanwhile, with the same inflation adjustment, small-fund investors averaged an 8%
gain over the 20-year periods measured. Their best result was a strong 13.5% from Janu-
ary 1975 to January 1995, their worst, 2.7% starting January 1955.

Of course, this doesn’t mean you’re guaranteed to make money buying small-cap funds.
Although the numbers show that it’s a good idea to stay in the market as long as possible,
they say nothing about how long you should hang on to particular funds. The overall les-
son, however, is simple: The market delivers its cruelest blows to those who cash out too

                                    Bear Market Blues

Didn’t investors lose money during the three year bear market after 2000?

Yes, but those who have stuck it out are singing a different tune! It seems that despite all
the negatives of 2003 — the war in Iraq, terrorism threats and ugly employment figures
— the long-awaited economic recovery finally came around. With the help of the lowest
interest rates in decades and generous tax cuts, the stock market ended 2003 with a bang:
the Dow was up 25.5%, the S&P 500 gained 28.7%, and the NASDAQ tacked on an im-
pressive 50%.

Many investors who bailed out after the 2000 stock bubble burst have come to regret
their decision. Those who stuck it out have enjoyed the market’s significant gains. Be-
cause the fact is, even though it could be quite some time before the losses of the three
year bear market are recouped, it’s going to happen. History has proved it.

                                  Types of Investments

   •     Stocks
   •     Bonds
   •     Mutual Funds
   •     Other Investments


Stock is ownership, simple as that. Buy a share of Microsoft and you acquire a tiny sliver
of the software giant, tying your fate to that of Bill Gates, for better or worse. This is
ownership in the most literal sense: You get a piece of every desk, contract and trademark
in the company. Better yet, you own a slice of every dollar of profit that comes through
the door. The more shares you buy, the bigger your stake becomes.
Bill Gates owns by far the most Microsoft shares. Over the past decade, his stake in the
company has hovered around 21%. But his stake also ebbs and flows with everybody
else’s stakes as the company’s value on the stock market changes from day to day.

Stocks are probably not the best investment for most of us who do not have the time or
resources to research them.

Here’s what Dave Ramsey (Christian financial advisor) has to say about investing in

Looking back at the last 78 years, the performance of the stock market as a whole has av-
eraged near 12% annually; yet the average return of the single stock investor is closer to
7% annually. Mutual funds typically hold 50 to 250 stocks in their portfolio. They hire
mathematical geniuses to determine exactly how long to hold them and when to sell them
to maximize returns. The average investor is simply not going to compete with the brains
of most mutual funds, long term. Also, if you place much of your nest egg with one or
two single stocks, your risk skyrockets. Your sleep will be much less restful when your
nest egg stock doesn’t meet earnings, sees it’s CEO locked up for fraud, or takes a 35%
plunge because the analysts decided your stock is a hold instead of a strong buy. If you
must satisfy your need to test your brother in law’s hot stock tip, then limit this invest-
ment to no more than 10% of your portfolio. NOTE: By the time you get the hot tip, it’s
old news to our friends inside the mutual funds.


A bond is a loan and its holder is the lender. Who’s the borrower? Usually, it’s the fed-
eral government, a state government, a local municipality or a big company like General
Motors. All of these entities need money to operate — to fund the federal deficit, for in-
stance, or to build roads and finance factories — so they borrow capital from the public
by issuing bonds.

A key difference between stocks and bonds is that stocks make no promises about divi-
dends or returns whereas bonds do.

When a company issues a bond, it pledges to pay back your principal (the face value)
plus interest. If you buy the bond and hold it to maturity, you know exactly how much
you’re going to get back (in most cases, anyway — there are some exceptions). Bonds
are also known as “fixed-income” investments — they assure you a steady payout or
yearly income. And although they can carry some risk, this regular income is what makes
them inherently less volatile than stocks.

Just because bonds have a reputation as conservative investments doesn’t mean they’re
always safe. Any time you lend money, after all, you run the risk it won’t be paid back.
Companies, cities and counties occasionally do go bankrupt or default on their debts for
extended periods. U.S. Treasury bonds alone are considered rock-solid.
By far, the greatest danger for a buy-and-hold bond investor is a rising inflation rate.
Why is inflation such a problem for bondholders? Think about it this way: Rising prices
make today’s dollars worth less in the future than they’re worth today. Since a bond can
lock up your money for as long as 30 years, a rising rate of inflation can have a particu-
larly corrosive effect.

Here’s what Dave Ramsey (Christian financial advisor) has to say about investing in

Bonds are often stereotyped as safe investments with returns slightly lower than stocks.
This simply is not the case. Bonds, just like stocks, are traded on the secondary market.
This means the value of bonds goes up and down each day just like stocks. The risk in-
volved with bonds is not significantly lower than stocks. In some cases, it is much higher.
Bonds are debt instruments, used by companies to raise capital. The bond payments
themselves are made by the companies and are dependent on the financial strength of the
individual companies. Good companies can miss bond payments. Got any Service Mer-
chandise bonds? Enron bonds? Also, the returns associated with bonds are not attractive
compared to stocks. It’s better to invest in balanced mutual funds which included bonds.
Balanced mutual funds mix stocks and bonds inside of a mutual fund. You can study the
track record of balanced mutual funds just like any other fund.

Mutual Funds

A mutual fund is a pool of money used to invest in whatever the fund specializes. Most
funds specialize in stocks but some buy gold, bonds or other investments. Many funds
focus on certain areas like China or US technology stocks.

Example: Fidelity Magellan is the largest fund in the country. The minimum investment
is $2500. Thousands of investors have put money into the fund which, in turn, invests the
money in US stocks, the fund’s specialty. A large full time staff monitors the investments
and makes decisions under the direction of a fund manager.

One appeal of mutual funds is that smaller investors receive the same world class exper-
tise and purchasing power as the large institutions. Investors who buy funds need only be
concerned with the quality and long term performance of the fund. They do not need to
worry about each individual stock or bond purchase the fund makes. Mutual funds are an
excellent way for investors to have their money handled by world class professionals.

Diversifying your investments will protect you from the market’s worst storms. The more
types of stocks or bonds an investor owns, the less any one of them can hurt them by
tanking. Depending on just a few investments is always asking for trouble. Yet building
and maintaining a diversified portfolio isn’t for everybody. To do it right, you might have
to keep an eye on as many as 20 to 60 different stocks and bonds at once. Some people
thrive on this sort of thing, but most of us lack the time, interest or experience to give a
complex portfolio the attention it demands. Mutual funds — pools of stocks or bonds that
are managed by professional investors — are an excellent way to diversify without all the
work of tracking stocks and bonds.

Funds come in all shapes and sizes, from Fidelity’s $68 billion Magellan Fund to the $20
million Women’s Equity Fund. Most of them work this way: A sponsor company like
Fidelity or Vanguard rounds up money and pays a portfolio manager to buy groups of
securities according to a specific investing strategy. The company then sells shares in the
fund to the general public at a price reflecting the value of the pooled securities. Buy a
share of the fund, and you own a small percentage of the total portfolio, meaning you par-
ticipate in any of the fund’s investment gains or losses. Depending on the fund, you can
own a piece of 20 to 500 different companies for a minimum investment of $1,000 to
$5,000 — sometimes even less.

You may have to pay a fee for the service, but a good fund offers plenty of advantages.
Ideally, the pros have years of experience and are given access to piles of industry and
company research. It’s also true that, unlike a bank certificate of deposit or an annuity, a
mutual fund investment is completely liquid, meaning you can get in or out simply by
picking up the telephone.

While diversification through mutual funds can help to buffer from the crash of one er-
rant stock, they’re still subject to market risk. If the broad market drops, then chances are
that your fund will usually sink right along with it. However, there are some mutual funds
that will perform well even through a bear market. Though mutual funds lessen the work
load of the investor, the wise investor still must do some homework. There are plenty of
lousy funds out there that charge you a lot in fees, and do badly even when the market
does well. It’s essential to choose your funds wisely and strategically.

Other Investments

                               CD’s (Certificate of Deposits)

A certificate of deposit or CD is a certificate issued by a bank that indicates a specified
sum of money has been deposited. The certificate guarantees to repay your principal —
the amount you deposited — with interest on a specific maturity date. The amount of in-
terest you receive depends on prevailing interest rates, the length of maturity and how
much you deposited. There are often significant penalties for early withdrawal of your
money. CDs are insured by the Federal Deposit Insurance Corporation (FDIC). That
makes your investment safe from everything but inflation.

For savings (emergency funds, saving for purchases, etc.) CD’s are great. As invest-
ments, they are poor. CD’s guarantee you a small return, which increases the longer you
commit to leave it. CD’s typically pay 1% or 2% per year. Inflation increases 3% to 4%
per year. If you invest in a CD and receive 2%, you’ll pay taxes on this gain (if not in a
retirement account like an IRA). You’re looking at an after tax return of 1.5%, when the
cost of living increased more than twice this amount. The only guarantee you receive is
that your money will lose value over time compared to the cost of bread, gas, electricity,
etc. Long term, you need to earn a minimum 6% annual return to pay taxes and be left
with enough to account for inflation so that your dollars do not lose value. In order to
grow your investment, you must outpace inflation. Mutual funds are the preferred vehicle
for long term investing.


Annuities are a big favorite of many brokers and financial planners. And it’s no wonder:
They’re easy to sell because they sound so safe and easy — a diversified, tax-deferred
investment that is protected from losses in case you die. They also can generate fat com-
missions for the folks who sell them. You can guess which part the planners emphasize to
their clients.

Except in a few limited instances, there’s really no point in buying an annuity. You can
get the same returns and tax benefits from a mutual fund held in your IRA or 403(b). And
the no-loss insurance is not worth the exorbitant fees you’re normally asked to cough up.

To see why, you first need to understand how an annuity works. Annuities generally
come in two varieties: fixed and variable (there are others, but these are the ones you will
most likely encounter). Insurance companies (through brokers) sell them as a sort of
combination retirement account/insurance policy.

You put your money in, and the principal is allowed to grow, tax deferred, for a set pe-
riod — usually until you’re 59 1/2. Then, you either “annuitize” what’s in your account
(which means you get steady payments over a fixed period of time) or you can take a
lump-sum distribution (which could leave you with a hefty tax bill). In either case, you’d
better be comfortable with the decision. Most of the time, you can’t change your mind.

A big part of the pitch, however, is the death benefit. If you die and your account has
dropped below what you originally put in, the insurance company makes up the differ-
ence to your beneficiary. But don’t be fooled: The death benefit is triggered in only three
of every 1,000 variable-annuity accounts, according to Limra International, an insurance-
industry research group.

The difference between fixed and variable annuities is that the “fixed” contract guaran-
tees you a set interest rate during what is known as the “accumulation period” — the time
before you take withdrawals. Oftentimes, however, if you read the fine print, you’ll find
that the great rate that’s being plugged only lasts for a brief period. After that, it can
change dramatically, although there may be a minimum interest-rate guarantee.

With a variable annuity, the return is based on your choice among a set of mutual funds,
bonds or cash-equivalent investments that is usually predefined. Because of this relative
flexibility, variable annuities are by far the most popular type of annuity. And you can
expect your broker to pump up the idea that the rate you earn is up to you.

The one big perk of an annuity is that, unlike an IRA or 403(b), it doesn’t limit the
amount of cash you can put in at any one time. That means if you max out your regular
retirement plans in a given year — but still have a chunk of money you want to sock
away for retirement — you might consider buying a low-fee variable annuity. Fortu-
nately, a few have become available over the past few years. T. Rowe Price, for example,
offers annuities with 1.31% annual expenses (for the insurance and the funds). And Van-
guard’s fees total only 0.67%. (For a more detailed discussion of when a variable annuity
might be right for you, see “Who Should Buy Variable Annuities?” on Smart-


Most annuities are notorious for the high fees they charge. On average, you’ll pay about
2.3% in basic fees for a variable annuity, compared with 1.4% for the average mutual
fund. And many variable-annuity providers tack on additional fees on top of that, like an
annual “contract charge.” Another problem is the taxes. Withdrawals from variable an-
nuities are taxed as ordinary income, which can run as high as 35%. But mutual-fund
shares held in taxable accounts for more than 12 months are taxed at the lower capital-
gains rates, which means you won’t owe more than 15% to Uncle Sam. Moreover, if you
die still owning the annuity, your beneficiary could owe income tax as well as estate tax
on the proceeds. That’s not true of mutual funds.

                                 Types of Mutual Funds

Why are there so many different types of funds? Mostly because there are so many dif-
ferent ways to invest. A fund manager’s job is to create a portfolio that blends different
types of stocks and bonds to achieve the maximum return for a given level of risk. Some
managers are more willing to roll the dice on risky stocks in search of high rewards. Oth-
ers are more defensive, seeking reasonable gains without the threat of big losses. Some
invest only in foreign stocks, some favor small companies, some like utilities — the list
goes on.

For investors, this diversity provides the opportunity to tailor a portfolio of funds to meet
particular objectives. Take a 55-year-old man eyeing retirement in a few years. Seeking
some growth but not much risk, he may put part of his money into a steady, large-
company equity fund, while protecting the bulk of his nest egg in a money-market fund
with lower — but virtually guaranteed — returns. A 30-year-old woman, on the other
hand, has years to make up for any short-term investment losses. So she may want to put
most of her money in a more aggressive equity fund that promises more risk, but higher
No Need to Get Fancy

There are funds geared to just about any investment objective — from funds that buy
only biotech stocks to those that invest only in Russian companies. This has encouraged
some investors to move in and out of funds like stock traders, trying to time the market.
What gets lost in the shuffle is a simple, time-honored principle: Investors do best if they
pick a set of promising funds and leave their money in them for the long term.

If all this sounds hopelessly confusing, it doesn’t have to be. Most people’s investment
objectives can be satisfied without getting fancy. The truth is, there are only a few broad
categories of funds that really matter to most people.

                                       Index Funds

These are mutual funds that seek to produce the same return that investors would get if
they owned all the securities in a particular index. The most common variety is an S&P
500 index fund, which tries to mirror the return of the Standard & Poor’s 500-stock in-
dex. Index funds have the lowest expense ratios in the fund universe and are also very
tax-efficient because of their low turnover ratios. They can be good funds for investors
who don’t want all the hassle of researching mutual funds.

Among investors, index funds can be a heated debate. Index funds are neither evil nor the
answer to all your investment needs. An index fund can be a part of a well-diversified
portfolio. As an investor, you should understand that index funds are not typically ac-
tively managed. If the index your fund mirrors plunges, so will your fund. Actively man-
aged funds on average trail index funds by 0.75 percent a year. To a large extent, this is
because of the greater expenses that actively managed funds charge.

Are index funds right for me? That’s the question many worried investors asked them-
selves during the bear market. Most everyone was a fan of index fund investing back in
the late 1990s, citing low fees, tax efficiency and all-around simplicity (and good returns
sure helped). From 1995 to 1999, when the S&P 500 (the index most favored by inves-
tors) returned more than 20% annually, it was easy to be a devotee of index funds. Things
got a whole lot harder when the index posted tough losses three years in a row.

In 2003, however, the sun came out once again and the index posted a 29% again. And
over time, the return of this index has been decidedly positive: Since 1926, it’s delivered
10% average annual returns. So while you shouldn’t necessarily expect a smooth ride,
index funds can still make up the backbone of a solid, long-term portfolio. After all, it’s
difficult to beat the S&P 500 in the long run. Yes, a terrific fund manager should be able
to beat the index. But most managers don’t. In fact, over the past five years, 53% of all
mutual funds have underperformed the S&P 500 on a cumulative basis.

The truth is, for many investors — particularly young ones just starting out — index
funds remain the easiest, most effective way to go. If the goal is long-term growth and
simplicity, these no-fuss funds are the best solution.
So how do they operate? Technically, index funds do have managers, but they don’t have
a lot to do. They simply buy all the stocks or bonds in a chosen index with the goal of
matching that group’s performance. And what’s an index? It’s a grouping of stocks cho-
sen to represent a certain market segment. The S&P 500 index, for instance, consists of
large stocks. The Nasdaq Composite index is heavy on technology companies. And the
Russell 2000 is a benchmark for small-cap companies.

Index funds have other advantages: tax efficiency and low expenses. Since the manager
doesn’t have to look actively for stocks, these funds are relatively cheap to operate. The
Vanguard 500 Index fund, for example, has an incredibly low annual fee of 0.18% of
your investment. The average large-cap fund charges more than seven times that much.

It’s always good to diversity. A good strategy is to invest not only in an index fund of
large-company stocks, such as the S&P 500, but also in a small-company stock index
fund and/or in a foreign stock index fund.

Bottom line? While index funds might not look all that attractive over the short term, they
are one of the best options around for long-term investors.

                                      Major Indexes

   The oldest, best known and most widely quoted stock market index. The DJIA re-
   flects a price-weighted average of 30 actively traded blue chip stocks. These 30 secu-
   rities represent between 15-20% of the market value of the New York Stock Ex-
   change traded stocks.
S&P 500
   An unmanaged group of stocks often considered representative of the stock market in
   general. This index is composed of 400 industrial, 20 transportation, 40 utility, and 40
   financial companies.

   A commonly cited index of small-cap stocks.

Exchange-Traded Funds

Exchange Traded Funds (ETFs) are a cross between a stock and an index fund. Like mu-
tual funds, ETFs are baskets of securities. Like stocks, ETFs trade on an exchange.
Unlike regular mutual funds, ETFs can be bought and sold throughout the trading day.
Anything you might do with a stock, you can do with an ETF.

An ETF invests in a basket of stocks which mimics a chosen market index. An investor
wanting to invest in an ETF may place an order with a broker just as he would do for any
stock, with a similar procedure for selling them. Unlike an index mutual fund, where
transactions are processed at the end of the trading day, investors can trade the ETFs on a
real-time basis. You can buy and sell shares of the ETF at any time the market is open.

On the plus side, ETFs have a lower management fee than most index funds. However,
an investor has to pay a brokerage fee each time he buys or sells an ETF. Even with the
low fees available at discount and online brokers these days, brokerage commissions can
seriously erode ETFs’ low-expense advantage, especially when investing small sums of

For example, if you were planning to invest, say, $100 a month in ETFs, even a cost of
just $10 per trade would mean 10 percent of your investment is being siphoned off. So
your ETFs’ price would have to rise 10 percent just to recoup your buying cost -- and
you’ll have to pay a commission when you sell too.

For this reason alone, ETFs are generally better suited for investors who are socking
away larger amounts of money — as in 401(k) and IRA rollovers. If you’re more likely
to be dollar-cost-averaging with small sums or you tend to invest sporadically with mod-
est amounts of money, you’re probably better off in a regular mutual fund.

Liquidity Risks of ETFs: While liquidity in a mutual fund is assured at NAV price, liquid-
ity in ETFs are not. Rather ETFs are linked to the demand on the stock exchange. If trad-
ing is light, there is a possibility that an investor may not be able to liquidate his ETF at
the chosen time.

Some ETFs offer an exit option to investors (through the fund) if there are no quotes on
the ETF for five consecutive days. However, the exit load imposed in this case is quite
large (2.5% of the NAV price).

                        A Comparison of ETFs and Index Funds

     Comparison                            ETFs                     Index Funds
     Tax Efficient                    Not always good                   Good
     Min Investment                   Roughly $5,000                     $50
     Dividend Reinvestment                   No                          Yes
                                 Brokerage Commission to
     Cost to Buy Sell                                          None on no-load funds
                                     both buy and sell
     Trades                    Minute by minute like a stock At the end of the day
                                    Stock Fund Types

Stock funds are often grouped by the size of the companies they invest in — big, me-
dium, small or tiny. By size we mean a company’s value on the stock market: the number
of shares it has outstanding multiplied by the share price. This is known as market capi-
talization, or cap size. Big companies tend to be less risky than small fries. But smaller
companies can often offer more growth potential. The best idea is probably to have a mix
of funds that give you exposure to large-cap, midsize and small companies.

Large-Cap Stock Funds

Large-capitalization funds generally invest in companies with market values of $8 billion
or more, according to investment-research firm Morningstar. Some, like the Vanguard
500 Index fund, merely mimic the index and invest in all 500 companies. Others, like Fi-
delity’s huge Magellan fund, try to beat the index by picking a mix of large caps that will
outperform the broader market.

Large-cap funds are typically less volatile than funds that invest in smaller companies.
But that doesn’t mean you shouldn’t expect some bumps along the road if you invest
purely in large caps. As we saw during the bear market (2000 to 2002), even the biggest
companies can stumble badly. Nevertheless, over the long term, a fund that invests in
well-established companies should offer a smoother ride than its smaller siblings. The
trade-off is that you can expect slightly smaller returns.

For most investors — particularly those with a relatively long investment horizon — a
good large-cap fund can create a solid cornerstone of a portfolio.

Mid-Cap Stock Funds

As the name implies, these funds fall in the middle. They aim to invest in companies with
market values in the $1 billion to $8 billion range — not large caps, but not quite small
caps, either. The stocks in the lower end of this range are likely to exhibit the growth
characteristics of smaller companies and therefore add some volatility to these funds.

That said, their solid long-term record combined with their reduced risk when compared
with small caps, makes them a good core holding for a young investor.

Small-Cap Stock Funds

A small-cap fund focuses on companies with a market value that’s typically below $1
billion. The volatility of the fund often depends on the aggressiveness of the manager.
The most aggressive small-cap managers buy hot growth and technology companies, tak-
ing big risks in hopes of big rewards. More conservative “value” managers look for com-
panies that have been beaten down temporarily by the stock market.
Because of their volatility, you should make sure when investing small-cap funds that
you have enough time to make up for short-term losses. There are times when the market
turns away from small-cap companies altogether for extended periods, as we witnessed
most recently in 1998. Since then, however, small-caps have performed remarkably well,
outperforming their peers during the bear market, and gaining a whopping 44% when the
market turned around in 2003.

What’s the bottom line? Small-cap funds can provide a good kicker for aggressive inves-
tors who need to build as much wealth as possible while they’re young.

Micro-Cap Stock Funds

We’re talking about the smallest of small fries here — companies with market values be-
low $250 million. These funds tend to look for start-ups, takeover candidates or compa-
nies about to exploit new markets. With stocks this small, the volatility is always ex-
tremely high, but the growth potential is exceptional. Wasatch Micro Cap, for instance,
sported a five-year average annual growth rate of nearly 29% at the beginning of 2004.
But, then again, during one three-month period in 2002, it shed 21.9%.

If you’ve got a strong stomach and some money that you won’t need anytime soon, it
could be worthwhile to invest in this type of fund. But beware: Micro-cap funds can rear
up and bite you.

                                  Stock Fund Strategies

Every manager is different, but there are three broad archetypes when it comes to invest-
ment strategies: value, growth and blend. The issue here is whether the manager is, a)
seeking to “discover” cheap stocks, betting that the market will eventually discover them,
too; or b) willing to chase popular (a.k.a. expensive) stocks, hoping to cash in on their

Value Funds

These funds like to invest in companies that the market has overlooked or lost faith in.
Managers search for stocks that have become “undervalued” — or priced low relative to
their earnings potential.

Sometimes a stock has run into a short-term problem that will eventually be fixed and
forgotten. Or maybe the company is too small or obscure to attract much notice. And then
there’s what can happen during times of economic uncertainty, when large groups of
stocks get broadly punished, even though a specific company’s fundamentals haven’t
necessarily changed. In any event, the manager makes a judgment that there’s more po-
tential there than the market has recognized. His bet is that the price will rise as others
come around to the same conclusion.
The big risk with value funds is that sometimes the “undiscovered gems” they try to spot
remain undiscovered. That can depress results for extended periods of time. With most
value funds, however, volatility is low, and if you choose a good fund, the risk of long-
term poor performance should be minimal. Also, because these fund managers tend to
buy stocks and hold them until they turn around, expenses and turnover are low. Add it
up, and value funds are suitable for many long-term investors.

Growth Funds

As their name implies, these funds tend to look for the fastest-growing companies on the
market. Growth managers are willing to take more risk and pay a premium for their
stocks in an effort to build a portfolio of companies with above-average earnings momen-
tum or price appreciation.

This group is the most volatile of the three investment styles. And unfortunately, when
growth slows, watch out — the more momentum a stock has, the further it’s likely to fall
when the news turns bad. That’s why only aggressive investors — or those with enough
time to make up for short-term market losses — should buy these funds.

Blend Funds

These can go across the board, investing in both growth and value stocks. They might, for
instance, hold some high-growth biotech stocks as well as some cheaply priced industrial
cyclical stocks. That means they’re tough to classify in terms of risk. The Vanguard 500
Index fund invests in every company in the S&P 500 and could therefore qualify as a
blend. But because it’s also a large-cap fund, it tends to be steady. The Legg Mason Spe-
cial Investment fund, on the other hand, is more aggressive, with more than double the
weightings in technology stocks than the S&P 500 as of the end of 2003. In order to de-
termine if a particular blend fund is right for your needs, you’ll probably have to look at
the fund’s holdings and make a judgment call.

                                International Stock Funds

It is indeed a small world, after all. But that doesn’t mean a good international fund
shouldn’t be in your portfolio. Although the gap is closing, the economies of the world’s
different regions still tend to boom and bust in cycles that offset each other. As a result,
international stocks can provide excellent diversification for a portfolio heavy on U.S.

International funds give you exposure to overseas markets at varying levels of risk. The
narrower their geographic region, the riskier they can be. Consider the pummeling Asian
funds endured during the outbreak of severe acute respiratory syndrome (SARS) in Sin-
gapore, Hong Kong and China. In just nine short weeks toward the start of 2003, Pacific
Asian funds (excluding Japan) lost 8%, according to Morningstar. Investors feared that
the outbreak could not be contained and fled the region. But those who stayed put were
rewarded when SARS fears soon receded.
Funds investing overseas fall into four basic categories: world, international, emerging
market and country specific. As always, diversification is the key to keeping risk in
check. A good fund manager can also help, since research is scarce and foreign compa-
nies are notoriously difficult for individual investors to track on their own.

World Funds

World funds are the most diverse of the four categories. But don’t be fooled by their
cosmopolitan-sounding name. They’re able to invest in any region of the world, including
the U.S., so they don’t actually offer as much diversification as a good international fund
would. A prime example: Dreyfus Founders Worldwide Growth, which is 60.6% invested
in North America and 37% invested in the United Kingdom and Western Europe.

World funds tend to be the safest foreign-stock investments, but that’s because they typi-
cally lean on better-known U.S. stocks.

Foreign Funds

These funds invest most of their assets outside the U.S. Depending on the countries se-
lected for investment, foreign funds can range from relatively safe to risky. Fidelity Di-
versified International, for instance, has its assets spread over more than 21 different
countries, many of which are in Europe. Templeton Foreign, on the other hand, has sig-
nificant exposure to some of the most traditionally volatile regions in the world, with a
24% weighting in Pacific Rim countries such as Thailand, South Korea and Hong Kong.
The average foreign fund has a less than 10% stake in these regions. The best thing to do
is to choose a fund with the best balance, or make sure the manager has done a good job
of moving in and out of regions profitably.

Country-Specific Funds

These funds invest in one country or region of the world. That kind of concentration
makes them especially volatile — particularly if you pick a fund that invests in a country
that’s viewed as an emerging market (see below). Granted, if you pick the right country
at the right time — like Russia in 2003, for example — the returns can be substantial. But
pick the wrong one, and watch out. Only the most sophisticated investors should venture
into this territory.

Emerging-Markets Funds

Emerging-markets funds are the most volatile. They invest in undeveloped regions of the
world, which have enormous growth potential, but also pose significant risks — political
upheaval, corruption and currency collapse, to name just a few. Of course, as the recent
bear market taught us, domestic stocks can be extremely volatile as well. So adding a
small slice of emerging-markets exposure to your portfolio could be one way to reduce
the overall risk of your portfolio. We still wouldn’t recommend this group to a short-term
investor, but long-term investors will find that the best way to cut risk is to have one’s
fingers in many pies.

                                    Sector Stock Funds

Sector funds do what their name implies: They restrict their investments to a particular
segment — or sector — of the economy. Vanguard Health Care, for instance, only buys
only health-care companies for its portfolio. No matter which sector you’re interested in
investing in, chances are there’s a fund that tracks it. Fidelity, for example, has a whole
stable of sector funds from Fidelity Select Insurance to Fidelity Select Automotive. The
idea is to allow investors to place bets on specific industries or sectors whenever they
think that industry might heat up.

While such a strategy might appear to throw diversification to the wind, it doesn’t en-
tirely. It’s true that investing in a sector fund definitely focuses exposure on a certain in-
dustry. But it can give you diversification within that industry that would be hard to
achieve on your own. How? By spreading your investment across a broad swath of

Of course, such concentrated portfolios can produce tremendous gains or losses, depend-
ing on whether your chosen sector is in or out of favor. For example, in 1999 technology
funds soared by an average of 135% — only to crash miserably during the next three
years. When the economy finally started to recover in 2003, however, these funds were
once again ahead of the pack, gaining 75.5%.

Needless to say, sector funds carry more risk than generalized funds. That’s why we sug-
gest that you don’t invest more than 5% of your total portfolio in a specific sector. But
some sectors are clearly more volatile than others. For example, MFS Utilities, which
holds mostly conservative, income-producing stocks, has about one-half the volatility of
the Franklin Biotechnology Discovery fund.

The lesson here? Sector funds are a great way to spice up a portfolio. But like Tabasco
sauce, a little goes a long way.

                                  Choosing Mutual Funds

If mutual funds are supposed to make investing easier, then why is choosing one so often
such an anguishing experience?

Maybe it’s because there are more than 8,250 funds available — 8,000 of which you’ve
never heard of before. Maybe it’s because an alarmingly large number of them lag the
market over the long run. A good mutual fund can help pay for your retirement. But what
makes a good fund and where do you find one?

The Web offers you some great research and information tools to aid you in your quest to
find the right funds. But before we get started with all the fine points of picking good mu-
tual funds, there’s something that you should know: You can save yourself a whole lot of
trouble and just about guarantee success by simply choosing an index fund and holding
on to it for the long haul.

Index Funds

As has been stated, index funds are cheap. They’re tax-efficient. And they routinely beat
the majority of actively managed funds. Over the past 10 years, only 30% of domestic
equity funds beat the S&P 500. And over the past 20 years, only slightly more than 12%
did, according to investment-research firm Lipper. What are the chances that you would
have picked one of the few winners? They’re probably pretty remote!

Fund of Funds

A fund of funds is exactly what it sounds like. It’s a mutual fund that invests in other mu-
tual funds. At first this may seem redundant to you, but here are some big advantages to
investing in a fund of funds:

   •   Double Diversification—A mutual fund diversifies across many different stocks.
       A fund of funds diversifies among many different funds.

   •   Simplicity—Instead of investing in many different funds to achieve the same re-
       sult, you can just invest in one fund. This allows for much less paperwork.

   •   Cheap for Beginning Investors—It’s tough to diversify when starting out be-
       cause of account minimums. A fund of funds allows the investor to diversify
       among hundreds or thousands of stocks in one small account.

   •   Institutional Advantages—A fund of funds can often invest in large institutional
       funds that are too expensive for small investors. They also have the ability to in-
       vest in some load funds without paying the load.

There are some of the disadvantages also:

   •   Extra Fees—Some fund of funds will charge fees at the “parent level.” Therefore
       you end up paying double maintenance fees. It would be cheaper for the investor
       to buy the same mutual funds themselves.

   •   Expense Ratios—Some fund of funds have high expense ratios which will drag
       down returns over time.

Depending on your situation, investing in a fund of funds may make sense for you. It is
an attractive option for new investors. Before investing in a fund of funds, take a close
look at the expense ratios to make sure they are not too high.
Life-Cycle Funds

Most people would be delighted to find a simple, one-stop-shopping opportunity to pick
investments. That would be an index mutual fund or a fund of funds — it’s like shopping
at Super Wal-mart. Better yet would be a one-shot-lasts-a-lifetime investment — one that
adjusts itself automatically as you get older and, presumably, more conservative. Now
there is such a product: life-cycle mutual funds.

Starting in the early 1990s, many mutual fund families began offering “life-cycle” funds
designed to carry investors from one stage of life to the next. Life-cycle funds, also re-
ferred to as “age-based funds” or “target-date funds”, are a special breed of the balanced
fund. They are a type of “fund of funds” structured between growth and preservation of
capital. The distinguishing feature of the life-cycle fund is that it automatically adjusts to
become more conservative as you approach retirement. Although lifecycle funds all share
the common goal of first growing and then later preserving principal, they can contain
any mix of stocks, bonds, and cash. The manager of each life-cycle fund periodically
shifts his holdings to a more conservative mix, replacing stock funds with bond funds and
bond funds with cash funds. A 2020 fund might have 70 percent stock holdings now, for
example, and be expected to have only 20 percent stocks when 2020 rolls around.

It’s a natural and desirable progression: The closer you get to retirement, the less expo-
sure you have to stock market gyrations and the more investments you have in stable, in-
come-producing securities.

That automatic rebalancing is a major attraction for life-cycle funds. The fact is that most
investors know they need to switch to more conservative allocations as they get older, but
many never get around to it. Surveys show people who participate in employer-sponsored
retirement plans often don’t change their asset allocations once they sign up because they
just don’t know what to do. Life-cycle funds put the decision on how to allocate your
contributions in the hands of professionals.

Life-cycle funds are a good choice for people who don’t have time, the energy or the in-
clination to manage a portfolio. It’s the simplest way to assure that you have a diversified
portfolio that is generally appropriate to your age.
Vanguard Example

To get a better understanding of how these funds work, let us compare two Vanguard
life-cycle funds. The Vanguard Target Retirement 2025 Fund is designed for people who
plan to retire in 2025. As of Sept 30, 2004, the asset mix for this fund was as follows:

In comparison, the Vanguard Target Retirement 2015 Fund has a more conservative mix.
It has more fixed income assets and also contains some inflation-protected securities.
Fidelity vs. Vanguard

While all life-cycle funds are similar in concept, they can be structured and maintained
differently. When shopping for a life-cycle fund there are some important factors to con-
sider. Let’s compare Fidelity and Vanguard—the two largest suppliers of these funds.
Both have different management styles for their funds.

Fidelity offers actively managed funds, while Vanguard uses passively managed funds.
Because of this Fidelity charges more in maintenance fees.

When comparing different life-cycle funds, beware that the same retirement date does not
necessarily mean the same level of risk. For example, the Fidelity Freedom 2025 Fund
has an equity weighting of 75% stock funds. Vanguard’s equivalent fund has an equity
weighting of 59% stock funds. Because of this the Fidelity Freedom 2025 assumes a
greater level of risk. You should not take this difference in the fund’s risk profile lightly.
You need to decide what type of risk exposure is right for you.

Many life-cycle funds, specifically the target date funds, use age as the overriding factor
in determining how much of your money to put in stock, bonds or cash. That concept is
OK if you believe that everybody who is 30 has the same tolerance for risk as everyone
else who is 30. However, your risk profile is not necessarily a function of age!

Here are some things to keep in mind:

Risk. Some managers choose more aggressive investments, and some choose to move out
of the stock market slower than others.

Cost. There are a few life-cycle funds that take a 5.75 percent of your investment upfront,
to pay sales commissions. As usual, Vanguard charges the lowest maintenance fees. Its
2025 fund, for example, has an annual expense of just 0.22 percent.

Life-cycle funds have gained popularity for their sensibility and simplicity. Many inves-
tors are overwhelmed by the responsibility of managing their retirement portfolio and by
the bewildering number of investing options facing them. Life-cycle funds bring sanity to
all of this with a solution that delivers simplicity, focus, and peace of mind.
Why Choose an Actively Managed Fund?

So if index funds or life-cycle funds are such a good solution, then why bother looking
for an actively managed fund?

Here are a few reasons ...

   •   Because you believe a certain fund manager can beat the market indexes.
   •   Because you want a fund manager who practices a particular style not offered by
       index funds.
   •   Because you want to invest in a specific market sector, like health care or finan-
       cial services. During the last bear market while the S&P 500 lost value many of
       the sector funds posted some great returns.
   •   Because you simply feel more comfortable knowing that a human being is picking
       the securities in your fund.

Life-cycle funds are great for many people, but not for all. They are mass-market prod-
ucts, with no allowances for individual circumstances, goals and attitudes about invest-

If you would like an actively managed fund, but you don’t want to spend the time doing a
lot of research, there are financial websites that offer good suggestions. Here are a few:

   •                           !     "        #      $
   •             %
It should be obvious, but before you can intelligently choose a mutual fund, you have to
have a basic understanding of how mutual funds work.

Define your investment goals. Are you saving for retirement? Putting some money aside
for a house down payment? Funding your children’s college education? Your answers
could lead you in several different directions and that could narrow the field of appropri-
ate funds significantly.
You should set up an asset allocation program, and then consider matching your fund
picks to your suggested allocations — large-cap stocks, intermediate-term bonds, etc.
Most studies show that a properly allocated portfolio is crucial to maximizing your re-
turns. Here’s a tool to help you determine an asset allocation program:

                            &           ' %   (     (   (

Finally, you have to decide how much risk you want to take. The more time you have un-
til you need your money, the more aggressive you can be. But you also have to consider
how comfortable you are with volatility. If your fund dips 5% or 10% one month, is it
going to keep you up at night?

OK, now the search can really begin. You know what type of fund you’re looking for —
let’s say you’re hoping to fill the large-cap stock portion of your asset-allocation program
— and you know how much risk you’re willing to take — a moderate amount, as long as
the returns are good. What you need is a way to narrow the field down to a manageable
list of potential candidates.

If you’re investing through a 403(b) plan, your choices may already be narrowed for you.
In that case, you simply have to find the fund that provides the best fit. Otherwise, there
are several ways to focus in. You can ask a broker to help you — an expensive option.
You can examine the offerings of a trusted fund company like Fidelity or Vanguard. Or
you can use a fund finder offered by a number of websites.
Here’s some useful tools:

   •             %
   •                              "    )          #       $'   )

You may have heard the phrase before: “Past performance is no indicator of future re-
sults.” It’s written in tiny print at the bottom of every mutual fund advertisement — right
below the part where they brag about their past performance. It’s true that investors
should never assume that the past will repeat itself. But those who ignore a mutual fund’s
historical record do so at their own peril. It’s the best measure we have of a fund man-
ager’s competence.

Interestingly, past performance is probably a better predictor for the stinkers than it is for
the highfliers. A 1998 study of ongoing performance by fund-tracking firm Morningstar,
found that while its four- and five-star funds (the best performers) didn’t necessarily re-
main atop the charts, its one- and two-star funds did continue to flounder. The lesson is
pretty obvious — you should always strive to avoid the perennial losers.

How should you evaluate performance beyond that? First, examine multiple time periods.
Many investors get burned by heeding the siren song of last year’s hot fund. Take the
Van Wagoner Emerging Growth fund (VWEGX), which finished 1999 above all U.S.
equity funds with a 281% gain, then plunged 21% in 2000 and more than 59% in 2001,
landing at the bottom of the barrel. Had you been wowed by the ‘99 gain, but checked the
fund’s three-year record, you would have seen its erratic history. That’s a red flag that
management isn’t fully in control.

What if you have a more ordinary that does not fluctuate wildly? How do you tell how
good that really is? The best way is to compare its numbers to both a relevant benchmark
index (like the S&P 500 or other funds in the same category) as well as other funds with
similar objectives. A great tool to help you evaluate mutual funds is Morning Star.
Here’s an example:

As you can see by the graph, this fund has outperformed both the S&P 500 and other
funds in its own category. It also has a 5-star rating which is the highest the Morning Star
gives. But you should remember that just because a fund gets a 5-star rating today is not
guarantee that it will maintain that 5-star rating.

It’s wise to make sure you’re comfortable with the fund’s risk profile and its propensity
for short-term volatility. After all, if your fund choice is going to make you sick with
worry, what’s the point?

Risk is generally a function of investing style. There are two broad categories most fund
managers fall into. Some managers chase popular, but risky, companies with high earn-
ings growth. Others look for undiscovered bargain stocks, hoping that their prices will
pick up over time. Growth funds (run by the former) tend to suffer wider short-term price
swings and more turnover. Volatility, of course, isn’t always bad — as long as it comes
with added returns. Value funds (run by the latter) are less volatile on the downside, but
you sometimes pay for that with less dramatic upside.

Morning Star ratings, which range from one to five stars (five being the best), take into
account both a fund’s performance and its risk for the life of the fund. Basically, Morn-
ingstar subtracts the fund’s risk score from its performance score. A five-star rating
means a fund has scored in the top 10% of its Morningstar category, while funds with
fours stars fall into the next 22.5% of their category, and so on down the line.

Please remember that “risk tolerance” has more to do with time than temperament. The
more time you have to make up for short-term losses, the more aggressive you can be
with your investments. The easiest way to reduce the risk of investing — and improve the
gain — is to increase the time you hang on to your investments. However, if you’re sav-
ing for a short-term goal, then your tolerance for risk would be significantly less.

You can never predict what a fund will earn next year. But you can almost always predict
what its expenses will be. So, why not control what you can? No-load funds with low an-
nual expenses are certainly preferable. Here are some tips:

   •   Try not to buy funds with expense ratios greater than the sector average. For
       large-cap funds, that was 1.30% at the beginning of 2003. For small-cap funds, it
       was 1.48%. For foreign-stock funds, it was 1.71%. And for taxable bond funds, it
       was 0.95%.
   •   When viewing similar load and no-load funds with equal returns, choose the no-
   •   However, don’t be so rigid as to always rule out load funds. Some funds like
       Growth Fund of America (AGTHX) have actually made up for their loads with
       strong returns and low volatility. Furthermore, many of the best-performing sector
       funds, like Fidelity Select Insurance (FSPCX) and Fidelity Select Financial
       Services (FIDSX), come with 3% sales charges. Generally, the longer you plan to
       stay in a fund, the less an upfront load matters.
   •   If you do buy a load fund, long-term investors should select the class “A” shares
       that charge a high upfront load, but have little or no annual fees (used for market-
       ing and distribution). Short-timers should stick with share classes that have low
       loads but higher 12b-1s.

Then there are taxes. They can sneak up and bite you, too, if you’re not careful. Unless
you hold your fund in an IRA or other tax-advantaged retirement account, a fund’s tax-
able distributions reduce your after-tax gain.

One of the best ways to avoid big distributions is to find funds with low turnover. That
means the manager isn’t churning his portfolio all year, generating capital gains in an at-
tempt to boost returns. The basic guideline is this: Investors should avoid funds with
turnover above 80%. (A turnover of 100% means the manager replaced holdings repre-
senting the entire value of the fund during the latest 12-month period.) The rule doesn’t
apply so easily to bond funds, whose securities mature and must be replaced. Remember
that index funds have a very low turnover.
Tax-conscious investors should also avoid funds with high dividend yields. That’s be-
cause dividends are taxed at income-tax rates as high as 38.6% (in 2003) rather than the
lower capital gains rates (on holdings of 12 months or more). And, if you’re really op-
posed to taxes, you should consider index funds, which are generally the most tax-
efficient type of funds. Their holdings should only change when the composition of their
benchmark index does or when the fund needs to pass out redemptions to shareholders.

While we’re on the topic of expenses, make sure to see if the minimum initial investment
of this fund is within your means.

When you invest in a fund, you’re really investing in a manager or a team of managers.
These are the people who decide when a stock or bond should be bought or sold for the
fund. When the manager leaves, much of the skill of running the fund goes with him or

This is less true of some of the bigger fund firms, such as the American funds, which are
run by teams of managers, and Fidelity and T. Rowe Price. All these companies have
skilled teams of analysts to supplement the work of the manager. With a team-managed
fund, you may never know exactly who is making the key decisions regarding the portfo-
lio. However, it can be reassuring to know that several people know the ropes at the fund,
and continuity is practically guaranteed if a manager departs.

So when you’re considering a fund, make sure you look at how many years the manager
has been on the job. If the manager has been around just two years, consider only those
two years in judging the fund’s record. The previous record belongs to someone else and
is beside the point. Likewise, if a manager has moved around a lot, it can be useful to
look at his returns from his previous jobs — information a fund company can furnish.

But what if you’re considering a fund with a new manager? Track down his or her previ-
ous record. (Often the manager transferred from another fund at the same fund company).
If the manager’s history is cloudy, consider buying a different fund. You should also keep
in mind that a change in fund management can often lead to high portfolio turnover (and
high taxes) as the new manager shapes the fund to his or her own liking.

To get to know a manager, read articles about him or her in Kiplinger’s Personal Finance
or other sources. Call the fund and order a recent annual report. Often funds will mail you
articles about the manager.
                                   Some Sound Advice

Don’t obsess over past results

Nothing is more attractive than a fund with a great record. With the market’s perform-
ance so pathetic in the last couple of years, any fund that boasts double-digit returns looks
like a lifesaver. But some lifesavers turn out to be waterlogged.

Past performance is a good starting point in your search for a great fund. But it’s hardly
the end of the quest.

Look for consistency

Don’t pay too much attention to the top-performing funds of the past 12 months. Recent
performance doesn’t mean a lot. What does is long-term success. Look at performance
over three, five, or ten year spans, more if possible. Also be sure that past performance
can be attributed to the current fund manager.

Any fund can get lucky — have a great few months, or even a year. What you want are
funds that are good year after year after year. That demonstrates an ability to do well un-
der any number of conditions, not just dumb luck. Compare the fund’s performance over
the past five years versus other funds that employ the same investment style.

Avoid comets — funds that have one great year and then flame out. A fund that’s in the
top 10% among its peers one year may turn out to be a comet in the longer run.

It’s not necessary for a fund to be in the top 10% every year, or any year, for that matter.
What you want are funds that stay above average almost every year.

Beware volatility

The issue of volatility is a tale of the tortoise and the hare, except that in this context the
hare sometimes wins the race. Like the hare, some funds bounce around a lot — topping
the performance charts one month only to end up in the cellar the following month.

Most investors should own both low-risk and moderate-risk stock funds. But a fund that
has achieved superior returns relative to its volatility rank is usually worth a close look.
Some studies show that such funds are more likely to continue to be good performers
than are funds that achieve slightly higher returns but with greater volatility.

Watch your dimes

Your chances of picking a fund that will deliver above-average results over time increase
the more you can get the wind at your back. This means keeping your eye on seemingly
small things, such as how much you pay in annual expenses to the fund. Every cent you
pay in expenses is money out of your pocket.
In general, you don’t want to pick a high-expense fund if there’s an equally attractive
fund with lower expenses. U.S. no-loads have an average expense ratio of 1.14%. Inter-
national no-load funds average 1.44% per year, and bond funds 1.10%. Expenses are es-
pecially important when choosing bond or money-market funds, where returns are some-
times slender.

A mutual fund with a high expense ratio is almost guaranteed to do poorly. An expense
ratio of 1.25 percent is normal. (Expense ratio equals expenses divided by assets.) When
funds do poorly, their shareholders leave and expenses go up. When funds do well,
shareholders climb on board and expenses usually go down (except in the case of espe-
cially greedy fund families).

In addition to keeping your expenses low, you should almost always avoid funds that as-
sess loads or sales charges. A load is a payment that goes to a financial adviser, broker or
insurance agent for helping you pick a fund, or sometimes it goes directly to the sponsor
of the fund. The load may be assessed when you buy the shares, or it may be taken out
annually in the form of a so-called 12b-1 fee, which can amount to up to 1% per year.
The point is simply this: If you’re picking a fund on your own, why pay this ransom?

Compare apples to apples

Funds can be divided into major investment styles, from funds that invest in stocks of
small, undervalued companies to funds that invest in stocks of large, fast-growing com-
panies. Comparing a fund with another fund that doesn’t practice the same investment
style is a bit like measuring the speed of an SUV against the speed of a race car. You
should evaluate a fund’s performance versus others that have the same investment style
(or against an appropriate benchmark index).

Don’t fall in love

The hardest thing about investing is knowing when to sell. It’s almost always more diffi-
cult than buying a fund. Once you’ve bought a particular fund, it’s yours and tough to let
go of, no matter how bad things get. The temptation is to hold on until you break even, or
at least until a fund bounces back. But bounces can be small and then cease. It’s very
hard to recognize (or admit) a mistake, cash in your chips and move on.

What’s the best way to surmount this hurdle? Look at your funds dispassionately, as you
would if you were deciding what to buy. If you wouldn’t buy one of the funds you own
today, then sell it, and replace it with something better.

Every fund has a bad year. Hold on if a fund falls behind its peers for a year. But after
two or especially after three years of below-average results, it’s time to either find out
what is holding the fund back and be satisfied with the explanation, or pull the plug.
Pay the piper

When you sell a fund that’s not tax exempt or tax deferred, you’ll likely have to pay capi-
tal-gains taxes. Funds are also required to distribute taxable gains to you and other inves-
tors at least once each year. Many investment “experts,” who should know better, advise
investors to stay with funds that have big gains (even if their prospects aren’t so hot), as
well as to shop for so-called tax-efficient funds — that is, funds that use techniques to
minimize the taxes you must pay until you sell your shares.

Those are bad ideas. The fact is, you will eventually have to pay taxes on your gains in
funds. The only question is whether to pay up sooner or later. The difference is peanuts,
no matter how tax-efficient the fund is — unless you can salt money away in a tax-
managed index fund for 20 or 30 years.

The thing to do is find the best funds you can and pay the taxes each year on your share
of their income and capital gains they produce. And don’t lose sight of one important,
and positive, aspect: The higher your taxes, the more money you’ve made.

Stay away from gimmicks

Mutual funds are in business to make money. At times, that means marketing takes the
lead over common sense. In the late 1990s, the market was flooded with technology and
Internet sector funds. The recent bear market has seen a propagation of bear-market
funds, gold funds and funds that claim they’ll do well no matter how the market behaves.

Unless your portfolio doesn’t have enough holdings in technology or health or real estate,
you’re probably best off avoiding sector funds. You are better off sticking to diversified
funds. Such funds give managers more freedom to invest in the best stocks they can find.
After all, that’s what you’re paying them to do.

                          A Few Notes on Taxes and Investing

Non-Retirement Accounts

With non-retirement accounts you may have to pay a Capital Gains tax and/or Distribu-
tions tax at the end of the year. If you sell all or a portion of your mutual fund you will
have to pay taxes on any gains that you made. That also true if you switch holdings from
one mutual fund to another mutual fund even if it’s in the same family of funds.

Retirement Accounts

It’s wise to put as much money as you can — as early as you can — in a tax-deferred re-
tirement account. The government has thrown you a bone. You simply can’t afford to
waste it.
Retirement accounts aren’t really magic, but they seem that way. That’s because your
earnings are allowed to grow tax-deferred until you reach retirement age. Over a long pe-
riod — say 25 years — the power of compounding will more than compensate for the
fact that your accumulated profits will eventually be taxed at ordinary rates as you liqui-
date the account. Compounding is a multiplier effect: The more you have in the account,
the faster it grows.

To see what we mean, take a look at the table below. It shows how much you’d have (af-
ter you pay your tax bill) if you invested $5,000 annually in a taxable account versus a
tax-deferred account over various time periods. As you can see, the longer your invest-
ment horizon, the better off you are investing in a deferred account.

                             Tax-Deferred vs Taxable Investing
                    After-Tax                        Taxable                         Tax-
                   Value After:                      Account                       Deferred
                        5 yrs.                        $21,555                       $22,572
                       10 yrs.                         51,090                       55,737
                       15 yrs.                         91,709                       104,468
                       20 yrs.                        147,726                       176,069
                       25 yrs.                        225,135                       281,275
            Figures based on a $5,000 annual pretax investment in the tax-deferred account and a compa-
            rable after-tax investment in the taxable account, with each earning an 8% average annual
            return. Source: T. Rowe Price Associates.

Of course, 403(b)s have other advantages. You’re reducing your annual taxable income,
which means a smaller bill each year come tax time.

403(b) Plan

This is a retirement-savings plan for employees of colleges, hospitals, school districts and
nonprofit organizations. The plan, which is similar to the 401(k) plan offered to many
corporate employees, is funded by employees with contributions that are deducted from
pretax pay. Employees manage the investment accounts themselves. Investment gains
aren’t taxed until the money is withdrawn after retirement. Withdrawals before age 59½
are subject to a 10% penalty charge.

Traditional IRA

This is another tax-deferred retirement plan that can help build a nest egg. Individuals
whose income is less than a certain amount can generally deduct some or all of their an-
nual IRA contributions when figuring their income tax. This can help reduce a person’s
tax burden. A 403(b) has the added advantage of also reducing self-employment tax. The
contributions grow tax-deferred until withdrawn. Withdrawals before age 59½ are subject
to a 10% penalty charge.
Roth IRA

This is a special type of IRA established in the Taxpayer Relief Act of 1997 that allows
taxpayers, subject to certain income limits, to save for retirement while allowing the sav-
ings to grow tax-free. Taxes are paid on contributions, but withdrawals, subject to certain
rules, aren’t taxed at all. A single person can contribute up to $3,000 and a married cou-
ple up to $6,000 annually to this type of individual retirement account. Those who will be
age 50 or older at year-end can contribute an extra $500 annually.

Under special circumstances you can withdraw funds from your Roth IRA before you
reach age 59½ without paying taxes or a penalty. How? Your Roth IRA funds must be at
least five years old. Also, the money you withdraw must be used specifically in cases of
disability, death, or the purchase of a first home ($10,000 lifetime limit) for you or your
immediate family.

                                     Asset Allocation

Diversifying Between Asset Classes

In its simplest terms, asset allocation is the practice of dividing resources among different
categories of investments. The theory is that the investor can lessen risk because each as-
set class has a different correlation to the others; when stocks rise, for example, bonds
often fall. At a time when the stock market begins to fall, real estate may begin generat-
ing above average returns.

The amount of an investor’s total portfolio placed into each class is determined by an as-
set allocation model. These models are designed to reflect the personal goals and risk tol-
erance of the investor. Furthermore, individual asset classes can be sub-divided into sec-
tors (for example, if the asset allocation model calls for 40% of the total portfolio to be
invested in stocks, the portfolio manager may recommend different allocations within the
field of stocks, such as recommending a certain percentage in large-cap funds, mid-cap
funds, small-cap funds, sector funds, etc.)

Asset Allocation Model Determined by Need

Although decades of history have conclusively proved it is more profitable to be an
owner of corporate America (i.e. stocks), rather than a lender to it (i.e. bonds), there are
times when stocks are unattractive compared to other asset classes such as bonds. A
widow, for example, with one million dollars to invest and no other source of income is
going to want to place a significant portion of her wealth in fixed income investments
that will generate a steady source of retirement income for the remainder of her life. Her
need is not necessarily to increase her net worth, but preserve what she has while living
on the proceeds. A young person just out of college, however, is going to be most inter-
ested in building wealth. He can afford to ignore market fluctuations because he doesn’t
depend upon his investments to meet day to day living expenses. A portfolio heavily con-
centrated in stocks, under reasonable market conditions, is the best option for this type of

Asset Allocation Models

Most asset allocation models fall somewhere between four objectives: preservation of
capital, income, balanced, or growth.

Model 1 - Preservation of Capital

Asset allocation models designed for preservation of capital are largely for those who ex-
pect to use their cash within the next twelve months and do not wish to risk losing even a
small percentage of principal value for the possibility of capital gains. Investors that plan
on paying for college, purchasing a house or acquiring a business are examples of those
that would seek this type of allocation model. Cash and cash equivalents such as money
market accounts, treasury bonds and commercial paper often compose upwards of eighty-
percent of these portfolios. The biggest danger is that the return earned may not keep
pace with inflation, eroding purchasing power in real terms.

Model 2 – Income

Portfolios that are designed to generate income for their owners often consist of invest-
ment-grade bonds, fixed income securities (bonds of large, profitable corporations), real
estate (most often in the form of Real Estate Investment Trusts, or REITs), treasury notes,
and, to a lesser extent, shares of blue chip companies with long histories of continuous
dividend payments. The typical income-oriented investor is one that is nearing retire-
ment. Another example would be a young widow with small children receiving a lump-
sum settlement from her husband’s life insurance policy and cannot risk losing the prin-
cipal; although growth would be nice, the need for cash in hand for living expenses is of
primary importance.

Model 3 – Balanced

Halfway between the income and growth asset allocation models is a compromise known
as the balanced portfolio. For most people, the balanced portfolio is the best option not
for financial reasons, but for emotional. Portfolios based on this model attempt to strike a
compromise between long-term growth and current income. The ideal result is a mix of
assets that generates cash as well as appreciates over time with smaller fluctuations in
quoted principal value than the all-growth portfolio. Balanced portfolios tend to divide
assets between medium-term investment-grade fixed income bonds and shares of large-
cap mutual funds. Real estate holdings via REITs are often a component as well.

Model 4 – Growth

The growth asset allocation model is designed for those that are just beginning their ca-
reers and are interested in building long-term wealth. The assets are not required to gen-
erate current income because the owner is actively employed, living off his or her salary
for required expenses. Unlike an income portfolio, the investor is likely to increase his or
her position each year by depositing additional funds. In bull markets, growth portfolios
tend to significantly outperform their counterparts; in bear markets, they are the hardest
hit. For the most part, up to one hundred percent of a growth modeled portfolio can be
invested in common stocks, a substantial portion of which may not pay dividends and are
relatively young. Portfolio managers often like to include an international equity compo-
nent to expose the investor to economies other than the United States.

Changing with the Times

An investor that is actively engaged in an asset allocation strategy will find that his or her
needs change as they move through the various stages of life. For that reason, some pro-
fessional money managers recommend switching over a portion of your assets to a differ-
ent model several years prior to major life changes. An investor that is ten years away
from retirement, for example, would find himself moving 10% of his holding into an in-
come-oriented allocation model each year. By the time he retires, the entire portfolio will
reflect his new objectives.
                                   Model Portfolios

The following are a set of model portfolios that are expected to achieve various rates of
return with the lowest amount of risk. These models suggest how you might balance your
portfolio based on your tolerance for risk.
Model Portfolios Continued
                              Common Allocation Mistakes

In building a retirement portfolio it’s important to accommodate what sometimes seem to
be conflicting goals. Of course, your strategy should be designed for your personal goals
and circumstances. These are only guidelines and there is no guarantee any particular
strategy will succeed.

Putting all your eggs in the equity basket

Even if you’re an aggressive investor comfortable with considerable fluctuations in your
portfolio value, consider keeping some part of your accumulation in other asset classes to
offset the volatility of stocks. Diversification is the best strategy for reconciling low risk
with strong performance.

Investing too conservatively

Even if you’re a cautious investor, you want to realize gains that outpace inflation over
time; otherwise it’ll be difficult, if not impossible, to fund the standard of living you want
and to maintain your purchasing power in retirement. Many people shy away from funds
that invest in stocks because they fear the stock market’s volatility but short-term swings
shouldn’t obscure its potential longer-term advantages. Putting even a small part of your
retirement portfolio in mutual funds that invest in stocks will allow you to benefit from
any high returns in the future.

Allocating long term to a Money Market Account

Money market accounts works best as a temporary holding place for funds if you’re un-
certain about where to put them and need time to decide. However, most money market
accounts do not even keep up with inflation.

Chasing performance

Constantly switching from one fund to another in pursuit of performance rarely works.
Market timing is especially hazardous, since you have to guess right twice predicting
both highs to sell on, and lows to buy on. If you don’t time your moves correctly, your
future retirement income will suffer, either because of actual losses or because of gains
you missed out on. Steady, consistent investment over time, combined with judicious pe-
riodic assessment of your needs, goals, and portfolio balance, offers a sensible approach
to retirement savings.
Ongoing supervision of a portfolio and its holdings to achieve maximum results. Active
management is one of the main benefits of investing in a mutual fund.

A fund that invests primarily in adjustable rate mortgage securities. Funds in this cate-
gory usually attempt to maintain a relatively stable net asset value, but can still be volatile
in times of rising or falling interest rates. During periods of rising interest rates, investors
stand to make more money, but homeowners faced with the prospect of paying more tend
to prepay, prematurely canceling the investor’s expected income. During periods of fal-
ling interest rates, the value of adjustable rate mortgages decreases relative to other fixed
income securities.

A fund with an investment objective of rapid growth of capital. Aggressive growth funds
usually include funds that invest in smaller companies, funds that invest heavily in a sin-
gle industry, and funds that employ riskier investment techniques such as leveraging and
short selling.

The company that takes primary responsibility for managing a mutual fund. The adviser
receives an annual fee for this service, usually ranging between 0.50% and 1% of a
fund’s total assets.

One of the largest private insurers of municipal bonds. This insurance provides that the
bonds will be purchased from an investor at par value should the bond issuer default.
Municipal bond funds featuring insured bonds tend to provide a higher degree of safety
than funds without such insurance, but they also tend to offer a lower yield.

Reports issued twice a year to a fund’s shareholders detailing the fund’s performance,
portfolio holdings and current investment strategy.

A tax-deferred investment product sold by insurers, banks, brokerage firms and mutual
fund companies. Fixed annuities provide a rate of return that is fixed for a year or so but
then can move up and down. Variable annuities allow investors to allocate their money
among a basket of mutual fund-like sub accounts; the return depends on the performance
of the funds selected. Watch out for high sales commissions, expense ratios and penalties
for early withdrawals.

An increase in a fund’s value.
ARMs (Adjustable rate mortgage funds)
ARMs are mortgages that require the real estate buyer to pay an interest rate that is peri-
odically adjusted. The amount of the rate is tied to some index outside the control of the
lender, such as the interest rate on U.S. Treasury bills. Like fixed-rate mortgages, ARMs
are often grouped by a government agency and sold as a single security, with investors
receiving payments out of the interest and principal on the underlying mortgages. Funds
that invest primarily in these ARM-backed securities are called Adjustable Rate Mort-
gage Funds.

A fund that invests primarily in the stocks of companies located in Asia. These funds ap-
peal to investors who believe that Asia potentially represents a growth area, and want to
capitalize on that growth.

Also known as the offering price, the ask price is the amount at which a mutual fund’s
shares can be purchased. To calculate the ask price, add a fund’s current net asset value
per share to its sales charge, if any.

An investment technique that diversifies a portfolio among different types of assets such
as stocks, bonds, cash equivalents, precious metals, real estate and collectibles. When it
comes to risk and reward, different asset classes behave quite differently. Stocks, for in-
stance, offer the highest return, but they also carry the highest risk of losses. Bonds aren’t
so lucrative, but they offer a lot more stability than stocks. Money-market returns are
puny, but it’s highly unlikely you’ll lose your initial investment. An asset allocation strat-
egy allows you to achieve the optimal blend of risk and reward.

A fund that invests in a variety of asset classes, including domestic and foreign stocks
and bonds, money market instruments, precious metals, and real estate. Some asset allo-
cation funds maintain a relatively fixed allocation between asset classes, while others ac-
tively alter the mix as market conditions change.

A debt instrument collateralized by credit card receivables, auto loans, or other assets and
securitized by a bank or other financial institution.

A fund’s investment holdings and cash. Holdings can include stocks, rights, warrants,
options, bonds, CDs, RANs TANs and BANs.

A shareholder service that allows the periodic withdrawal of a specified amount from the
shareholder’s bank account to be invested in his or her mutual fund account. Some mu-
tual fund groups also offer this service as a payroll deduction plan. (See also “dollar cost

A shareholder service that authorizes dividend and capital gain distributions to automati-
cally purchase more fund shares. Taxes still must be paid on the amount reinvested even
though no funds are received directly by the investor.

A shareholder service that entitles an investor to fixed payments, every month or quarter.
The payment comes from the dividends, income and/or realized capital gains on securi-
ties held by the fund. This service is often chosen by retirees who want to receive a regu-
lar income supplement.

A standard measurement of fund performance that includes dividends, gains, and changes
in share price.

The weighted average maturity date of a portfolio of bonds.

One of three possible sales charge schedules imposed by funds that charge fees. A back
end load, or “deferred sales charge,” is a fee charged when fund’s shares are sold. The
amount of the fee usually varies depending on how long the investment is held--generally
the longer the time period, the smaller the fee. Funds sold under several sales charge op-
tions usually refer to the shares sold with a back end load as class B shares.

Backdating is used in relation to funds that offer declining proportional sales charges of
larger purchases. This permits investors to count previous purchases of the fund’s shares
in qualifying for reduced loads or sales charges on subsequent purchases.

A fund with an investment objective of both long-term growth and income, through in-
vestment in both stocks and bonds. Typically, the stock/bond ratio ranges around
60%/40%. This broader diversification across asset classes tends to further reduce risk.

A fund that invests to provide a guaranteed return of investment at maturity (targeted pe-
riods). In order to achieve its investment objective, a balanced target maturity fund in-
vests a portion of its assets in zero coupon U.S. Treasury securities while the remainder is
invested in stocks that the manager believes will provide long-term growth of capital and
A bond management strategy where the portfolio is invested primarily in short-term and
long-term bonds, but in few bonds with intermediate maturities. In theory, this approach
allows one portion of the portfolio to take advantage of high yields, while the other por-
tion tempers risk.

The smallest measure used in quoting yields on fixed income securities. One basis point
equals one percent of one percent, or 0.01%.

Indicators used to provide a point of reference for evaluating a fund’s performance. The
most common benchmark for equity-oriented funds is the S&P 500 Index. For fixed-
income funds it is the Lehman Brothers Aggregate Bond Index.

A measure of a fund’s risk, or volatility, compared to the market which is represented as
1.0. A fund with a beta of 1.20 is 20% more volatile than the market, while a fund with a
beta of 0.80 would be 20% less volatile than the market.

Also known as the “sell” price, the bid price is the price at which a fund’s shares are
bought back by the fund. The bid price of a fund share is usually its net asset value.

A body of state laws governing registration and distribution of mutual fund shares. For
example, Blue Sky Laws require sellers of mutual funds to register the funds, and provide
financial details so that investors can base their judgment on relevant data. All 50 states
and the District of Columbia regulate mutual funds.

A fund that invests primarily in bonds, whether they are issued by corporations, munici-
palities, or the U.S. government and related agencies. Bond funds generally emphasize
income over growth, and can generate either taxable or tax-free income.

An investment strategy that first seeks individual companies with attractive investment
potential, then proceeds to consider the larger economic and industry trends affecting
those companies.

Dollar levels of investment in a fund that qualify you for reduced sales charges. The pur-
chases may either be made in a lump sum or by accumulating shares.
The possibility that bonds will be re-paid (or “called”) prior to maturity. This possibility
increases during periods of falling interest rates.

The profit made on an investment, measured by the increase in a fund share’s value from
the time of purchase to the time of sale.

A fund that invests primarily in common stocks the manager believes will provide maxi-
mum capital appreciation. Capital appreciation funds often resort to aggressive invest-
ment techniques, such as rapid portfolio turnover, leveraging, and investing in unregis-
tered securities in order to achieve their objectives.

A distribution to shareholders of profits realized from the sale of securities in a fund’s
portfolio. Capital gain distributions are usually paid yearly, and are currently taxable at a
rate up to 28%.

Also called capital appreciation, capital growth is an investment objective of many stock
funds. Capital growth is achieved when the market values of a fund’s holdings increase,
causing the fund’s net asset value per share to increase.

CDSC (Contingent deferred sales charge)
A type of back end load sales charge, a contingent deferred sales charge is a fee charged
when shares are redeemed within a specific period following their purchase. These
charges are usually assessed on a sliding scale, with the fee reduced each year the shares
are held.

A physical document representing the mutual fund shares owned. Certificates are rarely
issued, in the interest of economy and convenience. Shares are now recorded by the
Transfer Agent, or in a brokerage account (known as “street name.”)

Various classes of a single portfolio are distinguished by the type of sales charge they
levy. In general: -- Class A shares carry a front-end load. -- Class B shares carry a back-
end load (also known as a contingent deferred sales charge). -- Class C shares carry an
ongoing charge (usually in the form of an annual 12b-1 charge).

A fund launched to mirror a closed fund. For example, fund managers may decide to
close a fund that has grown so large it is no longer able to establish positions in smaller
securities. They could then launch a new fund in the closed fund’s image. While both
funds would have the same investment objective, they would generally be run by differ-
ent managers and would invest in different securities.

A fund that offers a limited number of shares. The shares of closed-end funds, which are
typically listed on one of the major stock exchanges, are bought and sold through brokers.
The price of the shares is determined by the pressures of supply and demand rather than
by the value of underlying assets.

Occasionally a manager may declare a fund “closed to new investors” which means that
no new investments will be accepted. This is often a temporary designation, prompted by
a tremendous amount of money invested in the fund in a short period of time. The portfo-
lio manager may be concerned about finding enough appropriate securities to add to the
fund’s portfolio.

A security collateralized with mortgages or mortgage-backed securities. Many CMOs
backed by a U.S. government agency are rated AAA. Non-agency CMOs may be lower

Debt instruments that are issued by established corporations to meet short term financing
needs. Such instruments are unsecured and have maturities ranging from 2 to 270 days.
Commercial paper is rated by Standard & Poor’s and Moody’s Investor Service.

A fee imposed when funds are bought or sold to compensate the broker for his or her role
in the transaction.

A fund that invests primarily in common stocks. The investment objectives of common
stock funds may vary greatly.

Interest earned on interest previously earned and reinvested. For example, if a security
paid a fixed interest rate of 10% annually and an investor invested $500, by the end of the
first year the investor would have earned $50 in interest. If that interest was reinvested,
the investor would enter the second year with $550 invested. At the end of the second
year, the investor would have earned $55 in interest -- earning an extra $5 in interest
thanks to the reinvestment of the first year’s interest.

A type of back end load sales charge, a contingent deferred sales charge is a fee charged
when shares are redeemed within a specific period following their purchase. These
charges are usually assessed on a sliding scale, with the fee reduced each year the shares
are held.

A program in which a legal vehicle (plan company or participating unit investment trust)
agrees to invest a fixed amount in a fund at regular intervals for 10 or 15 years. In ex-
change, investors in these plans commonly receive other benefits, such as decreasing
term life insurance.

Corporate securities (usually preferred shares or stock or bonds) that are exchangeable for
a set number of another form of security (usually common stock) at a pre-stated price.

A fund that invests primarily in convertible bonds and/or convertible preferred stocks.

A fund that invests primarily in corporate bonds. In general, corporate bond funds seek
income over capital growth.

A fund that invests primarily in the securities of a single country. In some cases, country
funds also invest in securities outside the single country if those securities are expected to
benefit by growth in that country.

The potential for price fluctuations in stocks sold in foreign countries due to events (po-
litical, financial, etc.) in these countries.

A measure of a bond issuer’s creditworthiness as rated by an independent agency, such as
Standard & Poor’s or Moody’s Investor Services. Ratings are set as a reflection of the
perceived financial stability of the issuer, from AAA to D. Bonds rated Baa or higher by
Moody’s, or BBB or higher by S&P, are considered “investment grade.” Conservative
investors tend to select funds composed of all AAA rated bonds, or “investment grade”
bonds. More aggressive investors, looking for high yields, are more interested in funds
that invest in lower rated bonds.

The possibility that a bond issuer will default, failing to repay principal or interest as
promised. “Credit risk” is also known as “default risk.”

The potential for price fluctuations in the dollar value of international stocks due to
changing currency exchange rates.
Annual interest or dividend payments expressed as a percentage of a bond’s current price.

CUSIP (Committee on Uniform Securities Identification Procedures)
A standard nine-digit code used to identify securities.

The organization (usually a bank) that keeps custody of securities and other assets of a

A type of back end load sales charge, a deferred sales charge is a fee charged when shares
are redeemed within a specific period following their purchase.

A decline in an investment’s value.

A financial security whose value is based on, or “derived” from, a traditional security,
asset, or market index.

The payment of dividends and capital gains to shareholders

The organization arranging for the sale of fund shares either directly to the public or
through intermediaries, such as financial advisers.

The practice of spreading investments among different securities to reduce risk. Diversi-
fication works best when the returns of the securities are varied, so that losses incurred by
securities falling in price are offset by gains of those rising in price. By nature, mutual
funds are a diversified investment.

Short-term profits, stock dividends or interest income which funds distribute to share-

A method of investing that calls for the investment of a set dollar amount at regular inter-
vals, regardless of the fund’s share price. As a result, more fund shares are bought when
prices are low than at high prices, usually bringing down an investor’s average cost per
share over time. Dollar cost averaging does not, however, guarantee a profit or protect
against a loss.
A fund that only invests in tax-exempt bonds of issuers from a single state. Income from
a double exempt fund is free of federal and state income taxes for investors residing in
the same state as the issuers of the bonds. Double-exempt funds have been particularly
popular in the high-tax states of California and New York. Double tax exempt funds are
usually subject in part or whole to the Alternative Minimum Tax (AMT). AMT percent-
age calculations for income tax purposes are available after each year end by contacting
the fund directly.

The oldest, best known, and most widely quoted stock market index. The DJIA reflects a
price-weighted average of 30 actively traded blue chip stocks. These 30 securities repre-
sent between 15-20% of the market value of the New York Stock Exchange traded

A closed-end fund offering two classes of stock in approximately equal amounts. One
class (income shares) is entitled to all the income from the fund’s portfolio (i.e., divi-
dends from investments). The second class (capital shares) is entitled to all of the capital
appreciation from the fund’s holdings. At the time a dual purpose fund is established, a
date is set on which the fund will be liquidated. At that time, income shareholders receive
preference up to the par value of their shares and capital shareholders receive any excess.

A fund that invests primarily in the stocks of companies in, or doing business in, develop-
ing countries and emerging markets. Emerging market funds usually have an investment
objective of long-term growth and are generally considered aggressive stock funds.

A fund that invests primarily in the stocks of companies in the energy business.

A fund that invests primarily in securities issued by environmental-related companies.
These include companies involved in hazardous waste treatment, waste recycling, and
other related areas.

A fund that seeks to provide relatively high current income and growth of income by in-
vesting a large portion of its assets in stocks.

A fund that only invests in the securities of firms meeting certain social standards. For
example, an ethical fund might exclude securities of companies that are known to prac-
tice discrimination, that operate in certain countries, or that produce specific products
such as alcohol, tobacco, or nuclear weapons.
A fund that invests primarily in the stock of Western European companies.

A shareholder service that allows shareholders to move their assets from one fund to an-
other fund within the same mutual fund family, usually without any additional sales
charge or fees. Fund groups vary in the specific parameters detailing when or how many
times an investor may use the exchange privileges.

An exchange traded fund (ETF) is a fund that trades like a single security or stock. It is a
fund comprised of baskets of securities (stocks) that reflect the composition of a stock
market index. The ETF’s value is based on the net asset value of the underlying stocks
that it represents. The main difference between ETFs and index mutual funds is that the
former is traded like a stock. ETFs are priced throughout the trading day whereas mutual
funds are priced at the end of the trading day. The Vanguard Group (an index fund spe-
cialist) currently has about two dozen funds in its ETF family, known as VIPERs.

The date on which a fund’s net asset value will fall by an amount equal to a dividend or
capital gains distribution. The ex-dividend date is usually the business day immediately
following the record date.

A fund’s operating expenses, expressed as a percentage of its average net assets. Funds
with lower expense ratios are able to distribute a higher percentage of gross income re-
turns to shareholders.

A fund’s cost of doing business. All of a fund’s expenses are disclosed in the prospectus
as a percentage of assets.

An investment management company offering funds with many investment objectives.
Fund families often allow investors to transfer money between funds for either a nominal
charge or no charge at all. Thus, an investor with shares in a growth fund could transfer
all or part of his or her assets into another fund without paying a new sales charge if each
of these funds is managed by a single investment firm.

A fund that invests primarily in the stocks of companies engaged in providing financial
services, including banks, finance companies, insurance and securities or brokerage
A security that pays a fixed rate of return. This term is usually used in reference to gov-
ernment, corporate or municipal bonds, which pay a fixed rate of interest until the bonds
mature, and to preferred stock, which pay a fixed dividend. Fixed income securities offer
the guarantee of a fixed return, but do not offer an investor much, if any, potential for

A fund that can invest in stocks, bonds and cash in whatever proportion the manager
deems appropriate, providing the manager total flexibility to achieve maximum returns.
Flexible portfolio funds are sometimes called asset allocation funds.

401(k) PLAN
An employer-sponsored retirement plan that enables employees to defer taxes on a por-
tion of their salaries by earmarking that portion for the retirement plan. Several invest-
ment options, including a range of funds, are generally offered.

403(b) PLAN
A type of individual retirement account (IRA) designed specifically for employees of
qualifying nonprofit organizations (i.e., public schools, public hospitals, churches). A
403(b) plan enables these employees to defer taxes on a portion of their salaries by ear-
marking that portion for the retirement plan. Several investment options, including funds,
are generally offered for investment.

One of three possible sales charge schedules imposed by funds that charge fees. A front
end load, or “upfront charge” is a fee charged on the initial purchase of fund shares, and
can range from 3% to 8% of the purchase amount. Funds sold under several sales charge
options usually refer to the shares sold with a front end load as “Class A shares.”

The investment of nearly all available assets in securities other than short-term securities
(such as savings and money market accounts). When a fund is said to be “fully invested,”
it usually implies that the fund’s manager is confident that the securities markets will be

A fund that invests only in the shares of other open-end funds. Fund of funds were popu-
lar during the 1960s but have subsequently fallen out of favor with most investors.

A fund that invests in bonds without any quality or maturity restrictions.

A fund that invests primarily in bonds issued by municipalities throughout the country,
and which generate federally tax-exempt income.
GNMA (Government National Mortgage Association).
Nicknamed Ginnie Mae, the Government National Mortgage Association is a govern-
ment owned corporation with the authority to fully guarantee the full and timely payment
of all monthly principal and interest payments on the mortgage backed securities collater-
alized by registered holders.

A mutual fund that invests anywhere in the world, including within the United States.
These can be either stock or bond funds.

A fund that invests primarily in securities associated with gold, including gold mining,
refining and production concerns. Gold funds are also sometimes referred to as precious
metals funds.

A fund that invests primarily in government fixed income securities, including U.S.
Treasury bonds and notes, and federally guaranteed mortgage-backed securities. Because
of the high quality of their portfolios, government income funds tend to be less risky than
other income funds, but to also offer less yield. In general, government income funds
seek to provide current income over growth of capital.

An investment objective of many stock funds. Current income, if considered at all, is a
secondary concern for these funds. Capital growth is achieved when the market value of a
fund’s holdings increases, causing the fund’s net asset value per share to increase.

A fund that invests primarily in the stocks of companies whose long-term earnings are
expected to grow significantly faster than the earnings of the market in general (as repre-
sented by the S&P 500 Index). In general, growth funds seek to provide capital gains,
rather than dividend income.

A fund that seeks to provide both growth of capital and a stream of income. This is done
by investing primarily in the common stock of companies that have had not only increas-
ing share value, but also a solid record of paying dividends.

A fund that invests primarily in growth stocks included in one of the major unmanaged
stock indices. Growth index funds generally seek to match or exceed the investment per-
formance of the targeted index.
An investment strategy to increase capital by buying stocks the manager believes will go
up in price, regardless of the stock’s current price relative to its underlying value. Growth
investing is often discussed in contrast to value investing

A fund that invests primarily in the stocks of companies in the medical industry.

A mutual fund that uses futures to offset investment risk. Hedge funds are a rich man’s
game. Investors put up minimums of $250,000 to $1 million. The funds promise high re-
turns. But the big money goes to the managers in fees and 15 percent to 20 percent profit
participations. In good year a manager can make tens of millions of dollars. But the risks
are also high. Managers gamble with investors’ money, betting with derivatives, options,
short-selling and leveraging for higher returns. So when the funds crash, they lose mega-
bucks. Yet sadly, America’s 8,800 hedge funds remain largely unregulated.

A fund that seeks to provide a relatively high current yield. High current yield funds tend
to invest primarily in lower grade fixed income securities without any quality or maturity

A fund that invests primarily in high yield bonds, also referred to as junk bonds. High
yield bond funds generally seek high returns and tend to be one of the riskier bond fund

Yield provided by a fund (typically a money market fund) over a specific time period.

The date a fund was first made available to investors.

1) Payments of dividends, interest, and/or short term capital gains earned by securities
held by a fund. Income dividends are paid after deducting operating expenses.
2) An investment objective of many fixed income funds. Capital appreciation is not a
consideration for these funds.

A fund that invests primarily in fixed income securities and/or high-yielding stocks. In
general, income funds seek to provide current income rather than growth of capital.
Indicators used to provide a point of reference for evaluating a fund’s performance. The
most common indices for stock funds are the Dow Jones Industrial Average and the S&P
500 Index. For fixed-income funds it is the Lehman Brothers Aggregate Bond Index.

A fund that invests in a collection of securities intended to match that of a broad-based
index (NOTE: It is not possible for investors to actually invest in the actual index, such as
the S&P 500). In general, index funds seek the same or a slightly better return that the
index they mirror. Index funds tend to charge low administrative expenses.

A personal savings plan that offers tax advantages to save and invest for retirement. Con-
tributions are often tax deductible in whole or in part, depending upon individual circum-
stances, including compensation levels and participation in an employer sponsored quali-
fied retirement plan. Income derived from investments in a traditional deductible or non-
deductible IRA are tax deferred until withdrawn. Under certain circumstances, withdraw-
als from a Roth IRA are tax free. Tax penalties may apply to IRA distributions taken be-
fore age 59 1/2. Contributions to an IRA may not exceed $2,000 per year. Individuals
with earned income may contribute up to $2,000 to the IRA of a non-employed spouse.

The rate at which the general level of prices for goods and services is rising. Inflation has
an uncanny ability to erode the value of securities that don’t grow fast enough. That’s
why investing only in a money market fund can be more risky than it appears on the sur-
face. If inflation is rising at 3% a year and your money market is growing at 5% or 6%,
you won’t have much money left over for your retirement. Measures of inflation include
the consumer price index (CPI) and the producer price index (PPI).

The possibility that the value of assets or income will be eroded by inflation (the rising
cost of goods and services). Inflation risk is often mentioned in relation to conservative
fixed income funds. While these types of fixed income funds may minimize the possibil-
ity of losing principal, they expose an investor to inflation risk.

A guarantee on a municipal bond that interest and principal will be paid timely and in
full. Insured bonds tend to carry a high credit rating but to pay a lower return than compa-
rably rated uninsured bonds. The largest municipal bond insurers include: The Municipal
Bond Investment Assurance Corp. (MBIA), Federal Guarantee Insurance Corp. (FGIC),
and AMBAC Indemnity Corp. (AMBAC).

A fund that invests primarily in investment grade fixed income securities with dollar-
weighted average maturities of five to ten years.
A fund that invests primarily in government guaranteed fixed income securities with a
dollar-weighted average maturity of five to ten years.

A fund that invests primarily in U.S. Treasury bills, notes and bonds with a dollar-
weighted average maturity of five to ten years.

A fund that invests primarily in the securities of companies located outside of the United
States. In general, international investing not only offers diversification and the potential
for high returns, but also involves special risks, such as currency concerns, and rapidly
changing political scenarios.

An investment company invests the pooled funds of investors in securities appropriate for
its stated investment objectives. For a fee, the investment company provides more diver-
sification, liquidity, and professional management service than is normally available to
individual investors.
Mutual funds, known as open-end investment companies, have portfolios that can grow
or be reduced, based upon market conditions and investor investment/redemption pat-
terns. Hence the name: they have limitless numbers of shares outstanding. Closed-end
funds, also called unit investment trusts, have a fixed portfolio, and a pre-set number of
shares outstanding.

High quality bonds that are rated Baa or higher by Moody’s, or BBB or higher by Stan-
dard & Poor’s. Investment grade bonds are considered safe, because the rating reflects
the perceived financial stability of the issuer. Usually, however, the higher the bond’s rat-
ing, the lower the interest it must pay to attract buyers.

A fund’s investment goal. For example, a growth fund typically has an investment objec-
tive of providing long-term growth of capital.

A description of a fund’s investment strategy. For example, a growth fund might have a
growth oriented style, a value-oriented style, or a blend of the two. Fixed-income funds
tend to be managed with either an interest-rate sensitive style or a credit-sensitive style.

IRA (Individual Retirement Account)
A personal savings plan that offers tax advantages to save and invest for retirement. Con-
tributions are often tax deductible in whole or in part, depending upon individual circum-
stances, including compensation levels and participation in an employer sponsored quali-
fied retirement plan. Income derived from investments in a traditional deductible or non-
deductible IRA are tax deferred until withdrawn. Under certain circumstances, withdraw-
als from a Roth IRA are tax free. Tax penalties may apply to IRA distributions taken be-
fore age 59 1/2. Contributions to an IRA may not exceed $2,000 per year. Individuals
with earned income may contribute up to $2,000 to the IRA of a non-employed spouse.

Bonds rated BB or below by Standard & Poor’s Corporation and Ba or below by
Moody’s Investor Service. Junk bonds tend to be more volatile and higher yielding than
bonds with higher quality ratings.

A fund that invests primarily in lower rated bonds (BB or below by Standard & Poor’s
Corporation and Ba or below by Moody’s Investor Service), also referred to as junk
bonds. Junk bond funds generally seek high returns and tend to be one of the riskier bond
fund investments.

A fixed income investment strategy that seeks to reduce interest rate risk by investing in
fixed income securities with a wide variety of maturities. Though this strategy assures
continuous cash flow, there may be some sacrifice of total return, since shorter-term
bonds tend to have lower yields than longer-term bonds.

Stocks of companies with market capitalizations of more than $1 billion. Large-caps tend
to be well established companies, so that their stocks entail less risk than smaller-caps,
but which also offer less potential for dramatic growth.

A fund that invests primarily in the securities of companies in Latin American countries.

An agreement calling for an investor to invest a specific amount in a fund over a defined
period in order to qualify for reduced sales charges. The reduced sales charge may apply
to an individual fund or to all the funds operated by a single investment management

The Lipper Analytical Indices are equally weighted indices of typically the 30 largest
mutual funds within their respective investment objectives. Returns are adjusted for the
reinvestment of capital gains distributions and income dividends.

A leading mutual fund research and tracking firm. Lipper categorizes funds by objective
and size, and then ranks fund performance within those categories.
The ease with which an investment can be converted into cash. Shares in a fund are gen-
erally considered highly liquid investments because they can be sold on any business day
for their then current value (which may be more or less than an investor’s original cost).

A sales charge assessed by certain mutual funds (load funds) to cover selling costs. A
front-end load is charged at the time of purchase. A back-end load is charged at the time
of sale.

A sales charge of 3% or less.

All funds other than short-term funds (i.e., money market funds).

The amount a fund pays to its investment adviser for its services. The average annual fee
industry wide is about one half of one percent of fund assets. A fund’s management fee
must be listed in its prospectus.

The Firm that provides the fund with investment research and portfolio management ser-

How long the portfolio manager has been responsible for a fund’s management.

Also referred to as “market cap.” Market capitalization is a measure of a corporation’s
value, calculated by multiplying the number of outstanding shares of common stock by
the current market price per share. Market capitalization is usually grouped into four
main categories: large-cap, mid-cap, small-cap, and micro-cap.

Attempting to time the purchase and sale of securities to coincide with ideal market con-
ditions. Mutual fund investors may switch from stock funds to bond funds to money mar-
ket funds as the strength of the economy and interest rate directions change.

The date on which the principal amount of a bond is to be paid in full.

The fee an investor pays when purchasing shares of a fund. A fund has different load
breakpoints depending on the purchase total.
For example, a fund may charge:
       4.5% to $100,000
       4.0% to $250,000
       3.0% to $500,000
       2.0% to $1 Million
       0.0% thereafter

A subset of small-caps. Stocks of companies with a market capitalization of less that $50
million are “micro caps.” Micro-caps tend to be new, relatively untested corporations that
can offer greater growth potential than larger caps, but also entail greater risk.

Stocks of companies with a medium market capitalization, usually defined as between
$500 million and $3-5 billion. Mid-caps are often considered to offer more growth poten-
tial than larger-caps (but less than small caps) and less risk than small-caps (but more
than large-caps).

A fund that invests primarily in the stocks of companies with a medium market capitali-
zation (mid caps).

The smallest investment amount a fund will accept to establish a new account. Most fund
groups also impose a minimum for additional purchases to an existing account.

Money market funds seek to maintain a stable net asset value by investing in the short-
term, high-grade securities sold in the money market. These are generally the safest, most
stable securities available, including Treasury bills, certificates of deposit, and commer-
cial paper. Money market funds limit the average maturity of their portfolio to 90 days or
less. They seek to generate monthly income, and to maintain a stable $1.00 per share net
asset value. Some money market funds offer check writing privileges. No fees are gener-
ally charged to purchase or redeem shares in a money market fund. Several different port-
folio types are available: Taxable, taxable government securities, and national or state

An independent mutual fund rating agency that tracks over 7,200 mutual funds. Of those,
Morningstar publishes full-page research reports on 1,500. Morningstar’s rating system
calls for the awarding of between 1 (the lowest) and five (the highest) stars to a fund for
its risk adjusted performance over a 3, 5, and 10-year period. Approximately 10% of the
funds rated earn five stars. Star ratings are recalculated monthly.
A security that returns principal and interest monthly as payments are received on the un-
derlying mortgages. They are made up of individual home mortgages guaranteed by the
government agencies. The mortgages are packaged into pools by agencies such as:
       • Government National Mortgage Assn. (GNMA)
       • Federal National Mortgage Assn. (FNMA)
       • Federal Home Loan Mortgage Corp. (FHLMC)

Unscheduled repayment of principal can shorten the maturity of the bonds. (See “Pre-
payment Risk.”)

A bond issued by a municipality to finance schools, highways, hospitals, airports,
bridges, water and sewer works, and other public projects.

An open-end investment company that combines the money of thousands of people and
invests it in a variety of securities in an effort to achieve a specific objective over time.
Mutual funds offer the benefits of portfolio diversification (which provides greater safety
and reduced volatility), professional management, and stand ready to buy back its shares
at the current net asset value. Every fund’s prospectus details information on the fund’s
objectives, fees, the management company, and more

An electronic stock market run by the National Association of Securities Dealers. Bro-
kers get price quotes through a computer network and trade via telephone or computer
network. The index that covers all the stocks that trade on this market is called the
NASDAQ Composite Index. Since there is no centralized exchange, NASDAQ is some-
times referred to as an over-the-counter market, or a negotiated marketplace. Many of the
stocks traded through NASDAQ are in the technology sector.

A fund that invests primarily in securities of companies that own, process, transport, or
market natural resources, which can include metals, minerals, and forest products.

The current market worth of a mutual fund’s share. A fund’s net asset value is calculated
daily by taking the funds total assets, securities, cash and any accrued earnings, deducting
liabilities, and dividing the remainder by the number of shares outstanding.

The net worth of a fund.

A fund that sells its shares directly to investors without a sales charge.
A fund’s investment objective states the financial goals it is aiming for, such as “growth,”
or “income.”

Also known as the “ask” price, the offering price is the amount at which a mutual fund’s
shares can be purchased. To calculate the offering price, add a fund’s current net asset
value per share to its sales charge, if any.

(Also known as “mutual fund.”) An investment company that pools money from share-
holders and invests in a variety of securities, including stocks, bonds, and money market
instruments. They offer growth, income, or both, and the opportunity to invest in every-
thing from a country or industry to the movements of the markets themselves. A mutual
fund continually sells new shares to investors and redeems those that are tendered by

The normal costs a mutual fund incurs in conducting business, such as the expenses asso-
ciated with maintaining offices, staff, and equipment. There are also expenses related to
maintaining the fund’s portfolio of securities. These expenses are paid from the fund’s
assets before any earnings are distributed.

A fund which trades options to increase the value of its shares. The fund may either be
conservative or aggressive. A conservative fund, commonly called an “option income
fund,” may buy stocks and increase shareholders’ income through the premium earned by
writing options on the stocks within the portfolio. An aggressive fund, commonly called
an “option growth fund,” may buy options in securities that the fund manager thinks will
fall or rise sharply in the near term.

A fund that invests primarily in the stocks of companies located in the Pacific Basin,
which includes Australia, Hong Kong, Japan, Malaysia, New Zealand, Singapore, and

A fund that invests primarily in the stocks of companies whose primary trading markets
or operations are concentrated in the Pacific region (including Asian countries), and
which specifically does not invest in Japan.

The day on which a mutual fund pays income dividend or capital gains distributions to its
A mutual fund accumulation plan in which sales fees for the entire obligation are de-
ducted from shares purchased in the first few years that the plan is in effect. In the event
that the investors redeem the shares after a short time, only a small portion of the pur-
chase price will be refunded. Sales charges and penalty plans are regulated by the In-
vestment Company Amendments Act of 1970.

A plan in which an investor agrees to make monthly or quarterly investments in a mutual
fund as a method of accumulating shares over a period of years. Fixed periodic contribu-
tions result in dollar cost averaging.

A measure of how well a fund is doing. Two commonly used mutual fund performance
measures are yield (which measures dividends) and total return (which measures divi-
dends plus changes in net asset value).

Pooling is the basic concept behind mutual funds. A fund pools the money of thousands
of individual and institutional investors who share common financial goals. The fund
uses this pool to buy a diversified portfolio of investments

A collection of securities owned by an individual or an institution (like a mutual fund). A
fund’s portfolio may include a combination of stocks, bonds, and money market securi-

The individual who is responsible for managing a mutual fund’s assets.

A measure of the trading activity in the fund’s portfolio of investments. In other words,
how often securities are bought and sold.

A fund that seeks an increase in the value of its holdings by investing at least two-thirds
of its portfolio in securities associated with gold, silver, and other precious metals. Also
known as “gold funds.”

The possibility that, as interest rates fall, homeowners will refinance their home mort-
gages, resulting in the prepayment of GNMA securities, and possible decline in net asset
values of GNMA Funds.

The basic amount actually invested, exclusive of earnings.
The pool of shareholder dollars invested in a fund is managed by full-time, experienced
professionals who decide which securities to hold, when to buy, and when to sell.

The official document that describes a mutual fund. It contains information required by
the Securities and Exchange Commission on such subjects as the fund’s investment ob-
jectives, policies, services and fees. A prospectus must be given to every investor. A
more detailed document, known as “Part B” of the registration statement, (or “Statement
of Additional Information,”) is available at no charge upon request.

The degree to which an asset’s correlation with “the market” has explained its fluctua-
tions over a specified period of time. Alpha and beta coefficients are calculated using a
procedure known as “regression analysis,” where points in a system of coordinates are
generated by measuring “market” movements (the “independent variable”) along the
horizontal “X” axis and correlating them with movements in the asset (the “dependent
variable”) measured along the vertical “Y” axis.
If the plot points clearly defines a straight line, the model will have an R-squared value of
close to 1.0, meaning that fluctuations in the market explain close to 100% of the relative
volatility in the asset.

If the pattern of plot points is largely random, the R-squared value will be near zero,
meaning that fluctuations in the market explain virtually nothing about fluctuations in the

A fund that invests primarily in stocks of companies that participate in the real estate in-
dustry, such as mortgages and real estate investment trusts, but not real estate itself.

A publicly traded company that manages a portfolio of real estate to earn profits for
shareholders. Patterned after mutual funds, REITs hold a diverse portfolio of real estate
such as apartment buildings, offices, industrial warehouses, shopping centers, hotels and
nursing homes. Shareholders receive income in the form of dividends from the rents re-
ceived on the property. To avoid taxation at the corporate level, 75% or more of a REIT’s
income must come from real property and 95% of its net earnings must be distributed to
shareholders annually. Because REITs must distribute most of their earnings, REITs pay
high yields of 5% to 10% or more.

The actual return earned on an investment after factoring in the rate of inflation.
The date on which a shareholder must officially own a stock’s shares in order to receive a
company’s declared dividend or to vote on company issues.

To cash in shares by selling them back to the mutual fund. Mutual fund shares are re-
deemable on any business day.

A fee charged by some funds when shares are sold (redeemed).

The price at which a mutual fund’s shares are redeemed (bought back) by the fund. The
value of the shares depends on the market value of the fund’s portfolio of securities at the
time. This value is the same as “net asset value per share.” In the newspaper, this amount
is shown as the “bid” price.

A shareholder who redeems fund shares, and then changes his or her mind, may have a
onetime privilege of reinstating the investment by investing the proceeds of the redemp-
tion at net asset value (with no sales charge). There is generally a 30-day time limit for
this service.

A contract under which an investor sells a United States security to a bank or Corpora-
tion, and agrees to repurchase the security later at a specified time and price. Purchaser
earns interest competitive with money market rates.

A municipal bond used to finance public works such as bridges, tunnels, or sewers. Prin-
cipal and interest on the bond are paid directly from the revenues of the project, such as
tolls. (Opposite: G.O., or General Obligation Bond, which relies on the taxpayers of a
municipality to repay the debt.)

A right granted by some mutual funds that allows a shareholder to count existing hold-
ings of the fund along with new purchases in determining the size of the sales fee on the
new shares. This right applies to funds that offer discounts on high-volume investments.
Thus the fee charged on succeeding purchases is determined by all purchases, past and
present, not just by new purchases.

ROA Right of Accumulation.
A right granted by some mutual funds that allows a shareholder to count existing hold-
ings of the fund along with new purchases in determining the size of the sales fee on the
new shares. This right applies to funds that offer discounts on high-volume investments.
Thus the fee charged on succeeding purchases is determined by all purchases, past and
present, not just by new purchases.

The reinvestment of funds into another, often similar, investment. Often used when secu-
rities are maturing, or when moving an Individual Retirement Account

A market-capitalization weighted index that is the best known benchmark of small-cap
stocks. It measures the 2,000 smallest companies in the U.S. market. These stocks repre-
sent only about 8% of the total market’s capitalization (as represented by the broader
Russell 3000 Index). As of the latest reconstitution, the average market capitalization of
the Russell 2000 was approximately $526.4 million. The largest company in the index
had an approximate market capitalization of $1.3 million. There are a number of index
funds that track the Russell 2000.

S&P 500
An unmanaged group of stocks often considered representative of the stock market in
general. This index is composed of 400 industrial, 20 transportation, 40 utility, and 40
financial companies.

A fund that invests primarily in the stocks included in the S&P 500 Index. Sometimes
referred to as “blue-chip” stocks, they tend to be of large, well-established companies.

A broad-based measurement of changes in stock market conditions based on the average
performance of 500 widely held common stocks. Performance figures assume that all
dividends are reinvested.

SAI (Statement of Additional Information)
An attachment to the fund’s prospectus that contains more detailed, supplementary in-
formation. Also referred to as “Part B,” the SAI is available at no charge upon request
from a fund.

An amount charged to purchase shares in many mutual funds sold by brokers or other
sales agents. The maximum allowable charge is 8.5% of the initial investment.

A fund that invests primarily in the stocks of companies engaged in science and technol-
ogy industries.

A standardized calculation that the Securities and Exchange Commission requires mutual
funds to use when advertising rates of income return. This standardized rate ensures that
investors are comparing “apples to apples” when comparing ads from different mutual
fund companies.

A fund that invests primarily in securities of companies engaged in a specific investment
segment. Sector funds entail more risk, but may offer greater potential returns than funds
that diversify their portfolios. For example, a sector fund may limit its holdings to securi-
ties from a particular country or geographic region, or it may specialize in the securities
of energy-related firms, or in companies that produce precious metals.

Funds that are organized with separate portfolios of securities, each with its own invest-
ment objective.

The date agreed upon by the parties to a transaction for the payment of funds and the de-
livery of securities.

An investor. The shareholder is the owner of shares of a mutual fund.

A fund that invests primarily in securities with maturities of less than one year. Short-
term funds include taxable money market funds and tax-exempt money market funds
(also known as short-term municipal bond funds).

A stamp or seal given by a bank or member of a domestic stock exchange that authenti-
cates a signature. A signature guarantee is typically required by a mutual fund sponsor to
conduct certain transactions, such as the change in ownership of an account.

Shorthand for small capitalization stocks, small-caps usually have a market capitalization
of $500 million or less. In general, small caps tend to be less established companies that
offer more growth potential than larger capitalized companies, but which also entail
greater risk.

A fund that seeks aggressive growth of capital by investing primarily in stocks of rela-
tively small companies with the potential for rapid growth.

A contractual plan for purchasing shares of a mutual fund in which sales charges are not
concentrated in the first payment or in the first few payments made by the investor.
A measure of the degree to which a fund’s return varies from the average of all similar

These funds invest in bonds issued by municipalities located all in one particular state.
Residents of that state earn income that is exempt from federal, state, and sometimes city
income taxes.

An attachment to the fund’s prospectus that contains more detailed, supplementary in-
formation. Also referred to as “Part B,” the SAI is available at no charge upon request
from a fund.

A fund that invests primarily in stocks.

A brokerage house practice of separating a bond into two separate securities: a principal
portion (PO) and an interest portion (IO). A variation known by the acronym “STRIPS”
(Separate Trading of Registered Interest and Principal of Securities) is a stripped zero-
coupon bond that is a direct obligation of the U.S. Treasury. Other strips include Treasur-
ies stripped by brokers, such as TIGERS, and Salomon Brothers’ tax-exempt M-CATS.

The movement of assets from one fund to another. Also know as “exchanging.” An in-
vestor will switch mutual funds when their investment objectives change or because of
market conditions. This is usually done within a family of funds, but can be done be-
tween different fund families. There usually is no charge for a certain number of transac-
tions per year, after which a transaction fee may apply.

An optional service often available to shareholders that would arrange for a fixed amount
to be redeemed from an account and sent to the shareholder on a regular basis (usually
monthly, quarterly, or semi-annually).

The 5-digit identifier code assigned to each mutual fund by NASDAQ. This code is used
to identify the correct fund in all transactions. This symbol may only loosely resemble the
newspaper listing--these tend to be phonetic abbreviations of fund names.

A fund that invests primarily in zero coupon U.S. Treasury securities, or in coupon-
bearing U.S. government securities targeted to mature in a specific year.
A fund that invests in municipal bonds. While investors do not pay federal income taxes
on the income from these funds, they may be subject to state or local taxes.

The yield that would have to be earned on a security to pay as much, after tax, as what is
earned from a tax-exempt bond.

T-BILL (Treasury Bill)
A fixed-income security issued by the U.S. Government.

A fund that invests primarily in the stocks of companies engaged in the technology indus-

The movement of an investor’s funds from one mutual fund to another on the basis of an
order given via telephone.

An investment approach that first seeks to define major economic and industry trends,
and then proceeds to identify specific companies that are likely to benefit from those
trends. (See also “bottom-up.”)

A measure of a fund’s performance that takes three factors into account: income divi-
dends, capital gains distributions, and share price appreciation/depreciation.

The date on which a purchase or redemption of mutual fund shares is conducted.

The process of changing ownership of an account within the same fund.

The organization employed by a mutual fund to prepare and maintain records relating to
the accounts of its shareholders. Some funds serve as their own transfer agents.

Fixed income securities issued by the U.S. government. Debt securities issued by the U.S.
Department of the Treasury. Because principal and interest is backed by the U.S. gov-
ernment, Treasuries are viewed as having no credit risk. Treasuries include:

   •   Treasury Bills (T-Bills) have maturities of one year or less. Maturities for T-bills
       are usually 91 days, 182 days or 52 weeks. Unlike Treasury bonds and notes,
       which pay interest semiannually, Treasury bills are issued at a discount from their
       face value. Interest income from Treasury bills is the difference between the pur-
       chase price and the Treasury bill’s face value. Bills are issued in denominations of
       $10,000 with increments of $5,000 for amounts above $10,000. Treasuries are
       widely regarded as the safest bond investments, because they are backed by the
       “full faith and credit” of the U.S.
   •   Treasury Notes (T-Notes) have maturities of two to 10 years. Treasury notes pay
       interest semiannually and can be purchased in minimum denominations of $1,000
       or multiples thereof. Treasury note yields typically are lower than Treasury bonds,
       which have longer maturities, but notes typically are about half as volatile as long
   •   Treasury Bonds (T-Bonds) have maturities of 10 to 30 years. Treasury bonds pay
       interest semiannually and can be purchased in minimum denominations of $1,000
       or multiples thereof. Until recently, the 30-year Treasury bond was considered the
       benchmark bond in determining trends in interest rates. (It was replaced by the
       10-year Treasury note.) It typically has a higher interest rate than other Treasuries,
       but more inflation and credit risk. But as a group, Treasuries are regarded as the
       safest bond investments, because they are backed by “full faith and credit” of the
       U.S. government.

A municipal bond mutual fund whose dividends and interest are exempt from federal,
state and local income taxes for residents of a particular state.

The rate at which the fund buys and sells securities each year. For example, if a fund’s
assets total $100 million and the fund bought and sold $100 million of securities that
year, its portfolio turnover rate would be 100%.

12b-1 FEE
The fee--named for an SEC rule--charged by some funds to pay for distribution costs,
such as advertising and dealer compensation. The fund’s prospectus outlines 12b-1 fees,
if any.

The organization that acts as the distributor of a mutual fund’s shares to broker/dealers
and investors.

Increases or decreases in the prices of securities held by the fund.

A fund that invests primarily in financial instruments issued or guaranteed by the U.S.
Treasury or its agencies.

A fund that invests primarily in securities issued by companies in the utilities industry.
The investment style of attempting to buy under priced stocks that have the potential to
perform well and increase in price.

A type of insurance contract that guarantees future payments to the holder, or annuitant.
Capital accumulates tax-free, often through investment in a mutual fund, and is converted
to an income stream at a future date (usually retirement). All monies held in the annuity
accumulate on a tax-deferred basis.

The amount by which the price of a security fluctuates as market conditions change.

A plan to acquire additional shares in a mutual fund on a more or less regular basis, at the
discretion of the shareholder.

A program in which shareholders receive payments from their mutual fund investments at
regular intervals.

Current income (interest or dividends) paid by a fund, expressed as a percentage of the
investment’s price.

A graph depicting yield as it relates to maturity. If short-term rates are lower than long-
term rates, it is called a positive yield curve. If short-term rates are higher, it is called a
negative, or inverted, yield curve. If there is little difference, it is called a flat yield curve.

The effective annual rate of return earned by a bond if held to maturity. This rate takes
into account the amount paid for the bond, the length of time to maturity, and assumes
coupon payments can be reinvested at the yield to maturity.

Bond issued at a discount which accrues interest that is paid in full at maturity.

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