Mutual Funds
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Transcript of Mutual Funds
Mutual FundsFinancial Literacy
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What We Will Cover
• What is a Mutual Fund?• Advantages and Disadvantage of
Mutual Funds• Costs of Mutual Funds• Types of Mutual Funds• ETFs• Buying a Mutual Fund
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What is a Mutual Fund?
• Investors pool their money• A fund manager buys a variety of
stocks• Each investor owns a share of the fund
(the total of all the stocks in the fund)• When the fund increases in value, the
investor makes money
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How Mutual Funds Work
Many investors (hundreds or thousands) put their money into the mutual fund pool.A professional manager will pick the stocks and bonds to buy
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Net Asset Value
• Mutual funds do not change price during the trading day
• The price you buy and sell for is called net asset value (NAV) rather than stock price• It is updated only once a day, at the end of
the trading day• Formula for NAV is: Total value of
securities minus debts divided by number of shares
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Open-Ended Funds
• This type of fund may issue as many shares as it wishes, and anyone can invest
• 95% of funds are open-ended
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Closed-End Funds
• Closed-end funds can issue a limited number of shares
• Investors buy and sell shares among themselves
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Advantages of Mutual Funds
• Diversification• You purchase a small amount of many
stocks without having to physically buy each stock
• Professional Management• Fund managers are professionals with
access to better information than the average investor
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Advantages of Mutual Funds
• Minimal transaction costs• Individual investors save on brokerage
fees compared to individual stock purchases. In a retirement account
there is no brokerage fee• Liquidity
• Easy to buy and sell• Flexibility
• There are over 8000 funds to choose from, allowing you to invest in an area you want
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Disadvantages of Mutual Funds
• Lower-than-market performance• On average, mutual funds underperform the market
• Costs• Always charge an annual fee• May also charge a sales fee• These fees will eat away your
profits
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Disadvantages of Mutual Funds
• Risk• Depending on the segment of the market
the mutual fund invests, it may do very well or very poorly
• Systemic Risk• A market crash will have a negative effect
on your fund
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Costs of Mutual Funds
• “Load” funds charge a commission to buy or sell the funds• Usually 4-8% of the investment
• “Front-end load” means you pay a commission when you buy
• “Back-end load” means you pay a commission when you sell the fund
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Costs of Mutual Funds
• “No-load” funds mean you don’t pay a sales commission
• Some funds will charge a fee if you sell within a specific period of time, such as 90 days
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Costs of Mutual Funds
• Owners of mutual funds pay an annual expense• Known as the expense ratio• Typically it is .25 to 2 percent of the
investment value• Try to buy a fund with the lowest
expense ratio (annual fee) possible• Expenses can eat up all or most of your
profits, especially if the fund isn’t performing well
Costs of Mutual Funds
• Annual fee• You will have to pay an annual fee even if
your mutual fund did not make money that year
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Costs of Mutual Funds
• Taxes• Generally you will have to pay taxes on
the profits every year, except in a retirement account
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Costs of Mutual Funds
• 12b-1 fee• These are marketing expenses passed on
to the investor• They do not benefit the investor at all
• Try to find funds that have minimum or no 12b-1 fees• They will eat into your profits and do not
provide any benefit to the investor
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Types of Mutual Funds
• Stock funds• Most popular types of
funds• These funds invest
mostly in stocks, but may also invest in cash, bonds, and money market funds
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Types of Stock Funds
• Aggressive Growth Funds• The fund buys stocks that will (hopefully)
increase dramatically in price• Very volatile
• Small-Company Growth Funds• Investments are limited to small
companies• Volatile
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Types of Stock Funds
• Income Funds• Concentrate more on strong companies
paying dividends (the dividends are the “income” in income funds)
• Less risky than aggressive growth funds• Growth-and-Income Funds
• Concentrate on stocks providing dividends plus the potential for growth
• Less volatile
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Types of Stock Funds
• Sector Funds• Specializes in stocks from a specific
industry• Computer, financial services, biotech precious
metals, etc.• International
• Invests mostly in stocks outside the U.S.
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Types of Mutual Funds
• Balanced funds• Holds both stocks and bonds
• Asset Allocation• Balanced funds with market timing
Types of Mutual Funds
• Life Cycle Funds (relatively new)• Attempt to tailor holdings to the investor’s
age and risk tolerance• The fund is managed based on how close
you are to retirement
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Types of Mutual Funds
• Bond funds• Invest in bonds rather than stocks• Emphasize income over growth
• Types of bond funds (remember than when you buy a bond, you are actually lending money to the company or the government)• U.S. Government bonds• Municipal bonds (bonds issued by city or
state)• Corporate bonds (from a company)
Index Funds
• Index funds will directly mirror an index:• DOW (DIA and others)• S & P 500 (SPX and others)• Nasdaq (QQQ and others)
• Inverse index funds will directly mirror the opposite of the market
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ETFs (Exchange Traded Funds)
• ETF’s are available for any segment of the market, just as mutual funds are
• Lower expenses than mutual funds
ETF’s
• There are also inverse ETF’s which will make you money when the market goes down• However, you will lose money when the
market goes up
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Buying a Mutual Fund
• Determine your goals• What are you investing for?
• Retirement• Education• Income• Growth
• Meeting your objectives• Make sure the fund meets your goals
(above)
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Evaluate the Fund
• www.morningstar.com identifies funds by investment strategy and management style
• Look closely at past performance and expenses
• Compare funds in the same category; do not compare a growth fund to an international fund, for example
• Look for “star” ratings (4-star and 5-star ratings)
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Buying a Mutual Fund
• You can purchase through your company’s 401(k) website
• You can purchase directly from the mutual fund company
• You can purchase from your broker• You can purchase through your bank• Many funds will let you invest with as
little as $100 in a retirement account