Objectives • WHAT IS A MUTUAL FUND? • HOW DO MUTUAL FUNDS OPERATE? • HOW MUCH DOES MUTUAL FUND INVESTING COST? • HOW SHOULD MUTUAL FUND PERFORMANCE BE EVALUATED? • WHAT ARE OTHER TYPES OF INVESTMENT COMPANIES?
What is a Mutual Fund? A MUTUAL FUND IS AN INVESTMENT COMPANY THAT SELLS SHARES REPRESENTING AN INTEREST IN A PORTFOLIO OF SECURITIES.
Advantages of Mutual Funds • DIVERSIFICATION • SMALLER MINIMUM INVESTMENTS • PROFESSIONAL MANAGEMENT
How Do Mutual Funds Operate? • Net Asset Value (NAV) • (Total portfolio value - liabilities) / # of shares • Management is usually contracted to an outside firm with fees ranging from 1/4% to 1/2% a year. • Often management companies will start many funds and will provide advisory services, etc. for them.
Services Offered by Mutual Funds • AUTOMATIC REINVESTMENT OF DISTRIBUTIONS • AUTOMATIC INVESTMENT PLANS • CHECK WRITING • EXCHANGE PRIVILEGES • PERIODIC STATEMENTS
Taxation of Mutual Funds • Mutual fund taxes are passed through to investors. Mutual funds are generally considered to be unfriendly from a tax standpoint. • Why?
Mutual Fund Fees and Expenses LOAD CHARGES • FRONT-END LOAD • BACK-END LOAD EXPENSES • MANAGEMENT OR ADVISORY FEES • OPERATING EXPENSES 12B-1 FEE
$26,000 $24,000 $22,000 $20,000 Investment Value Fund A: Annual operating $18,000 expenses equal .75%. $16,000 $14,000 Fund B: Annual operating expenses $12,000 equal 2%. $10,000 0 1 2 3 4 5 6 7 8 9 10 End of Year EVALUATING FEES AND EXPENSES DIFFERENCES IN ANNUAL OPERATING EXPENSES
Other Types of Investment Companies • UNIT INVESTMENT TRUSTS UNMANAGED PORTFOLIO OF A SPECIFIC TYPE OF SECURITY; INVESTORS PURCHASE UNITS. • CLOSED-END INVESTMENT COMPANIES MANAGED PORTFOLIO OF SECURITIES WITH A FIXED NUMBER OF SHARES OUTSTANDING.
Open-end Fund (Mutual Fund) • new shares sold as demanded. • company will buy back the shares at any time.
Closed-end Investment Company • set number of shares / bought & sold on exchange • market price usually < NAV, but . . . • emerging markets funds • changes in the discount affect total return • dividend yield usually above average because of discount • must pay commission to buy or sell
Load vs. No-load • most all funds obtained through brokers will have a load • load = sales fee • price = NAV + sales fee of 7 1/2% to 8% • usually no redemption fee • no-load funds are sold at NAV • low-load funds have a fee of only about 3%
Tradeoffs Between Loads and Fees • many no-load funds charge up to 1 1/2% per year for management • some low-loads do this also. • all funds charge management fees of from 1/2% to 1 1/2%. • *** Read Prospectus ***
Types of Investment Companies • Common stock funds • growth • income • index • mixed • industry specific (health care, airlines, etc.) • ecology minded • regional funds
Types of Funds, con’t. • Balanced funds • stocks and bonds • percentages vary greatly • See prospectus for strategy • Bond funds • corporate, government, junk, capital gains plays • mixed, municipals (state specific), income • Money market funds
Performance • After expenses, most funds do not consistently beat the market • Performance figures do not take taxes into account • The funds that tend to be the best in a given year do not tend to continue to perform at the top. Why?
Implications of Performance Studies • For investors with little money? • For investors with more money? • Advisability of diversification among funds?