INVESTING INMUTUAL FUNDS

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INVESTORSpool their money and

buy shares in the MUTUAL FUND.

ABC XYZ MUTUAL FUND

FUND MANAGER selects and purchases a variety of investmentinstruments.

Mutual Fund Basics

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Advantages of Mutual Funds: Diversification—risk is lowered; one share

buys a slice of everything in the fund.

Professional management—pay someone else to make investing decisions.

Financial returns—relatively attractive returns over the long term.

Convenience—easy in & out, small outlays, help with record keeping.

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Open-End Investment Companies (mutual funds)

– Dominant type of investment company

– Shares purchased from and sold back to company. Shares are not traded among individual investors.

– New shares issued as money flows in.

– NAV is usually the quoted price.

Types of Investment Companies:

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– Current value of all securities held in fund’s portfolio.

– Open-end funds buy back their own shares at NAV.

Net Asset Value (NAV)

NAV =

Current market price of all fund assets

(Less any liabilities)

Divided by the number of outstanding shares

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– Operate with a fixed number of shares outstanding.

– All trading is done between investors on the open market.

– Shares frequently trade at a discount or premium to net asset value.

Closed-End Investment Companies

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– Typically structured as index funds.• Spiders based on S&P 500• Diamonds based DJIA• Qubes based on Nasdaq 100

– Trade on listed exchanges like closed-end funds.

– Numbers of shares outstanding can be increased or decreased, depending on demand, like open-end funds.

Exchange-Traded Funds

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– Usually sold by brokerage houses.

– Investors purchase a share in an unmanaged pool of investments.

– No trading of securities within the portfolio once the trust assets have been purchased.

– Tend to have relatively high transaction costs and yearly fees.

Unit Investment Trusts

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– Closed-end investment companies whose trust assets are limited to real estate investments.

– Offer a more diverse and marketable way to invest in real estate.

– Equity or property REITs invest in properties; mortgage REITs invest in mortgages; hybrid REITs invest in both.

Real Estate Investment Trusts (REITs)

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Mutual Fund Cost Considerations: Loads = sales commissions

– Front-end load funds (or simply "load funds") charge a commission when shares are purchased.

– Low-load funds hold commissions to 2–3% when shares are purchased.

– Back-end load funds charge a commission when shares are sold.

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12(b)-1 Fees—annual fees for marketing and promotion.

Management Fees—annual fees charged by all funds to pay the fund manager.

No-Load Funds—no fee to purchase or redeem shares and low or no 12(b)-1 fees.

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– Total sales charges and fees cannot exceed 8 1/2%.

– Of this amount, 12(b)-1 fees cannot exceed 1%.

– Funds cannot call themselves “no-load” if their 12(b)-1 fees exceed 0.25%.

Maximum allowable fees:

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– Funds are required to disclose all fees in their prospectus.

– Even no-load funds can have high annual expense ratios and/or 0.25% 12(b)-1 fees.

– Fees affect your return, and annual fees will be collected regardless of the performance of the fund.

Keep Track of Fees!

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Types of Funds Growth Aggressive

Growth Value Equity-Income Balanced Growth & Income Bond

Money Market Index Sector Socially

Responsible International Asset Allocation

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Automatic Investment Plan—mutual fund periodically drafts money from investor's bank account.

Automatic Reinvestment Plan—fund earnings and distributions automatically reinvested in additional shares of fund.

Regular Income—fund automatically pays out to investor predetermined amount periodically.

Services Offered by Mutual Funds:

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Retirement Plans—funds set up and administer retirement plans for self-employed individuals.

Conversion Privileges—allow shareholders to easily move from one fund to another within the fund family.

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Making Mutual Fund Investments

Selecting a Mutual Fund:

Match the fund's objectives with your investment objectives.

Consider your tolerance for risk and your investment time horizon.

Read the prospectus!

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Check the fees charged.

Consider the fund's longer-term returns as well as its shorter-term returns.

Refer to Exhibit 13.8 concerning mutual fund facts every investor should know.

Assess the fund's services.

13-19Mutual Fund Performance: Returns consist of :

1) dividend/interest income earned by the fund assets;

2) realized capital gains distributions from sale of assets within the fund;

3) change in mutual fund's share price.

Past performance reveals success of fund managers but does not guarantee future returns!

MEETING RETIREMENT GOALS

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Pitfalls in Retirement Planning

Starting too late.

Putting away too little.

Investing too conservatively (especially when you are younger).

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Retirement Planning

At what age do you want to retire?

Start early in your career devoting money toward your retirement goals.

1. Set Your Goals:

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2. Estimate Your Needs:

Determine household expenditures.

Estimate income.

Consider the effects of inflation.

Decide how you will provide for the difference between income and needs.

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3. Establish Investment Program:

Create systematic savings plan.

Identify appropriate investment vehicles.

Consider tax implications.

Develop investment plan.

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10%29%

20%

41%

Government stillprovides the largestportion—right now.

Government Assistance, including Social Security

Income-Producing Assets

Pensions

Other

Sources of Retirement Income

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Social Security Benefits are provided by payroll

taxes you and your employer pay (you pay both halves if you are self-employed).

Amount of benefits may be insufficient by the time you retire.

Think of it as an insurance system rather than a retirement plan.

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Why SS may be in trouble:

The number of people retiring is increasing.

The number of people who work and pay taxes for retirement benefits is decreasing.

Eventually more money may be flowing out of the system than is flowing in.

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Pension Plansand

Retirement Programs

Employer-sponsored retirement programs

Self-directed retirement programs

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Participation requirements — are you eligible to participate in the program?

Contributions — am I required to contribute to my own plan or not?

Vesting — how long before I can take the money with me if I leave?

Retirement age — when can I retire?

Qualifying — does it qualify for tax deductibility?

Employer-Sponsored Programs:

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Defined Contribution: company guarantees a contribution, but not a return on the contribution or a retirement benefit.

Defined Benefit: company guarantees the benefit in retirement despite good or bad performance of the pension fund.

Defined Benefit vs.

Defined Contribution Plans

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Profit-sharing plans — employees benefit from company's earnings.

Thrift and savings plans — employer contributes to employee's fund. Employee contributions NOT deductible.

Salary reduction plans — employee contributes part of salary; contributions tax deductible; employer may also contribute as in a 401(k), 457, or 403(b).

Supplemental Plans:Allow employees to increase retirement funds. These plans are often voluntary, and contributions may be tax deductible.

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Keogh Plans — for professionals or small business owners and employees.

SEP Plans — for professionals or small business owners with few or no employees; simple to administer.

IRAs — for any working American; other self-directed plans may allow greater contributions.

Self-Directed Retirement Programs:Allow individuals and the self-employed to set up tax-deferred retirement plans for themselves and their employees.

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Traditional Tax-Deductible IRA — for those with no employer-sponsored plan or with incomes below a certain level.

Traditional Non-Deductible IRA — for those with an employer-sponsored plan and incomes over a certain level.

Roth IRA — contributions not deductible; for those with incomes below a much higher level, regardless of employer-sponsored plans.

Types of IRAs:Each year, you must EARN at least as much as you contribute to an IRA.

13-34More on IRAs: Maximum total yearly contribution to all IRAs

combined is $4000 (as of 2005) or your earned income (whichever is less).

Non-working spouse can also contribute up to $4000 (as of 2005).

An IRA is not an investment; it is a tax-sheltered account. A variety of types of investments (ex: bank CDs, mutual funds) can be held in an IRA account.

Returns on your IRA depend on your choice of investments.

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Coverdell Education Savings Accounts:

Earnings grow tax free for future education costs of a child or grandchild.

Contributions are NOT deductible, but withdrawals are tax and penalty free for qualified expenses.

Withdrawals must be made by the time beneficiary is age 30.

$2000 (as of 2003) maximum yearly contribution.

13-36For Qualified Retirement Plans in General :

Contributions grow tax free. If contributions were initially tax deductible,

money taxed as current income when withdrawn.

In general, you must be 59 1/2 to start taking distributions.

Early withdrawals are subject to a 10% penalty plus income taxes.

When moving accounts, have transfer made directly from one custodian to another.

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Annuities

Tax-sheltered investment vehicles administered by life insurance companies.

An agreement to make contributions now in return for a series of payments later.

Contributions NOT tax deductible.

Expected amounts, Plug in expected return and standard

deviation. See ranges.

Long range probability estimates