Mutual FundsChapter 14

Pool $ from Investors

Investor A = $1,000.

Investor B =

$1,000.

Investor C =

$1,000.

Investor D =

$1,000.

Investor E =

$1,000.

Investor F =

$1,000.

What is a Mutual Fund?

• A professionally managed groupgroup of investments bought using a pool of money from many investors

• Individuals buy sharesshares in the mutual fund

What is a Mutual Fund?

• Fund managers use this money to buy stocks, bonds and securities

• InvestmentInvestment ObjectivesObjectives determine the kinds of securities purchased

Family of Funds

• Variety of funds covering a whole range of investment objectives

• Fidelity has over 175 different mutual funds

• Advantage of using a “family fundfamily fund” - can trade in and out of funds within group• provides an opportunity to diversify • i.e. $5,000 to invest: 25% in aggressive

stocks, 25% in growth, 50% in income fund

Professional Fund Managers

Buy & Sell based on:market conditionseconomic conditionstrends+ other factors

Investors share in dividends & capital gains

Buying Mutual Funds

• Initial purchase $500 - $3,000• Can add additional monies at any time

Advantages of Mutual Funds

• Professional Management - managers follows the stocks and bonds

• Vanguard Health Care Fund Investor Shares (VGHCX)

• Let’s take a look at the managers

• ManagementWellington Management Company, LLP

• Firm Description

• Founded in 1928, Wellington Management Company, LLP, Boston, Massachusetts, is among the nation’s oldest and most respected institutional investment managers. The firm has advised Vanguard Health Care Fund since 1984.

• Investment Manager Biography

• Edward P. Owens, CFA, Senior Vice President and Partner• Portfolio manager. • Advised the fund since 1984. • Worked in investment management since 1974. • B.S., University of Virginia. • M.B.A., Harvard Business School.

• Direct research

Advantages of Mutual Funds

• Liquid• Diversification - purchasing a variety of

stocks and bonds• Low investment minimum - pooling

your money with other investors

Types of Mutual Funds

GROWTH FUNDGROWTH FUND - investment goal is to buy stocks that will increase in value over time

-- companies that reinvest profits rather than give dividends

-- earn profits via capital gains-- assume high risk for chance of high returnAggressive growth fund - new or out-of-favor

companiesOther growth funds - slower, steadier rate of

growth-- risky

Types of Mutual Funds

INCOME FUNDINCOME FUND - investment goal is to buy securities that consistently pay good dividends

-- companies that usually pay dividends rather than reinvest in company

-- invests in bonds that pay regular interest

Types of Mutual Funds

-- looking for income rather than capital gains

-- moderate risk

Types of Mutual Funds

GROWTH AND INCOME FUNDGROWTH AND INCOME FUND - investment goal is to earn return from dividends + capital gains

-- moderate risk

Types of Mutual Funds

BALANCED FUNDBALANCED FUND - attempts to minimize risk by investing in a mixture of:

stocks (preferred and common) bonds (corporate and municipal)-- provides both income and growth-- low-risk Goal: current income and long-term

growth with safety

Types of Mutual Funds

BOND FUNDSBOND FUNDS - invests in bonds to try to achieve stable income with minimal risk

Invests in: governmentcorporatetax-exempt bonds

-- most low-to-moderate risk-- risky if investing in junk bonds

Types of Mutual Funds

GLOBAL FUNDSGLOBAL FUNDS - purchases international stocks and bonds as well as US securities

Appreciate when:> stock markets abroad are strong> world conditions favor certain

overseas markets

Types of Mutual Funds – Global cont.

> fluctuations in currency exchange rates

-- can be an income fund, growth fund, aggressive growth fund, etc.

Types of Mutual Funds

INDEX FUNDSINDEX FUNDS - (index is an average of the price movements of certain selected securities)

-- tries to match the performance of a particular index by investing in the companies included in that index

-- S & P 500 / Dow Jones Industrial Average

SPY mutual funds follow S&P 500 index

Types of Mutual Funds - Index

-- risk level depends on index it is tied to - tied to DOW = low risk (blue

chips)

Types of Mutual Funds

MONEY MARKET FUNDSMONEY MARKET FUNDS - invests in safe, liquid securities, such at Treasury Bills and bonds that mature in 3-6 months

-- maximum safety

Research

• Go to www.morningstar.com• Click on “funds”

Minimum Investment Required

Minimum Investment Required

Evaluating Mutual Funds

To choose --> you must know YOUR OWN investment objectives & risk tolerance

Do you want income from your investments now, or can you wait for capital gains in the future?

Evaluating Mutual Funds

Do you need a tax-free or tax-deferred investment to reduce your current income taxes?

Are you comfortable with risking your investment for a chance at big returns, or do you prefer a safe but lower return?

Net Asset Value (NAVNAV)

• Prices NOT determined by what people are willing to pay

• Prices ARE determined by NAVNAV• NAVNAV = total value of a fund’s

investment portfolio minus its liabilities, divided by the number of outstanding shares of the fund

Net Asset Value (NAVNAV)

Value of Portfolio - Liabilities NAV = Number of Shares

$100,000 - $90,000 500 = $20

-- calculated at the END of each business day

Prospectus

• Legal document that offers securities or mutual fund shares for sale

Contains: terms summary of funds portfolio investments objectives financial statements - showing past performance

Before Buying

• Read the prospectus carefully• Compare objectives with your own• Compare past performance with that of

other funds

Costs and Fees

LOADLOAD - sales fee paid for mutual fund

FRONT-END LOADFRONT-END LOAD - sales charge paid when you buy an investment

BACK-END LOADBACK-END LOAD - sales charge paid when you sell an investment-- fees can range from 2 to 8% of the value of shares purchased

NO-LOAD FUNDNO-LOAD FUND - no sales fee (no salesperson - direct purchase)

Costs and Fees

• Annual Annual Management/Administrative FeeManagement/Administrative Fee - charge to manage fund• 1 to 1-1/2% of funds total assets

• 12b-1 Fee12b-1 Fee - charge for marketing and distributing fund (part of expense ratio)

Pg. 389

• Review How to Read the Mutual Funds Listings

Direct Real Estate Investments

Real EstateReal Estate - land and any buildings on it

--> often increase higher than inflation over time

--> least liquid--> sometimes speculative ( possible loss)

Direct Real Estate Investments

Commercial PropertyCommercial Property - land and buildings that produce lease or rental income(office buildings, stores, hotels, apartments)

Direct Real Estate Investments

Invest DIRECTLY or INDIRECTLY

Direct - investor holds legal title to the property

EXAMPLES OF DIRECTDIRECT:Raw Land

Vacant land / unimproved property

speculative investment - hold and sell later for profit

must pay cash - banks unwilling to make loans

Detached Houses

• Purchase single-family home and rent• Bank reluctant to make loans (not

owner-occupied)• larger down payment• higher interest rate

Duplex

• A building with two separate living quarters

• same responsibilities to renters as the owner of a single-family home

Condominium

• An individually owned unit in an apartment-style complex with shared ownership of common areas

• Owner of condo owns the individual apartment as well as a proportional share of common areas, such as the lobby, yard, and hallways

• Monthly fee for upkeep of common areas

Recreation & Retirement Property

• Retirement - buy second home for vacation or retirement years

• Rent property when owners are not there

• Recreation - beach, mountain cabins, and vacant land

• Rent the property

EXAMPLES OF INDIRECTINDIRECT:

• Investors appoint a trustee to hold legal title on behalf of all the investors in a group

• Trustee - individual or institution that manages assets for someone else

real estate syndicates / real estate investment trusts / mortgage pools

Real Estate Syndicates

• Group of investors who pool their money to buy high-priced real estate

• Temporary group organized for the purpose of raising large capital amounts

• Organizer called = general partner/syndicator

• Investors = limited partners

Real Estate Syndicates

R e a l E s ta te S yn d ica te

L im ited P artn e r$ 25 ,000

lim ite d lia b ility

L im ited P artn e r$ 15 ,000

lim ite d lia b ility

L im ited P artn e r$ 20 ,000

lim ite d lia b ility

G e n era l P artn e rF o rm s P a rtne rsh ip

A ssu m e s U n lim ited L ia b ility

Real Estate Investment Trusts (REITS)

• Similar to a mutual fund - corporation pools money of many individuals to invest in real estate

• REIT makes all buy/sell decisions• Trade on stock exchanges• include rental properties for monthly

income / mortgages for long-term income

Participation Certificates

• Investment in a pool of mortgages that have been purchased by a government agency

• “Ginnie Mae” “Freddie Mac” “Fannie Mae”

• secure as Treasury securities• $1,000 investment

PRECIOUS METALS

• Natural substances that people value

• Gold• Silver• Platinum

• Inflation causes price up when quantity & quality remain same

Gemstones

• Precious stones

• Diamonds• Rubies• Saphires• Emeralds

usually sold as jewelry

Collectibles

• Valuable or rare items

• Antiques• Comic books• Coins

• Most risky - often hard to find buyer• Thus, illiquid

Commodities

• Futures – contracts to buy/sell commodities or stocks

• Wheat• Corn• Soybeans• Cattle• Metals – gold, silver

Option

• Call Option – right, but not the obligation to buy/sell commodity or stock for a specified price within a specified time period

• Put Option – right, to SELL

Other Investment Choices

• Investing in precious metals, gems, futures contracts and options are all VERY RISKY - not for novice