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FIN 200: Personal Finance
Topic 20–Mutual Funds Lawrence Schrenk, Instructor
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Learning Objectives
1. Define a mutual fund. ▪
2. Outline the main types of funds.
3. Describe the returns from and costs of a mutual fund. ▪
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What and Why? What is a mutual fund?
Investment company that pools money Investors own a proportionate share of the
fund to the amount of their investment divided by the total value of the fund
Why were they developed? To give smaller investors access to
professional management and to increase the assets of mutual fund companies
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Advantages of Mutual Funds Diversification Full-Time Professional Management Modest Capital Investment Minimal Transaction Costs Services Offered Convenience/Liquidity
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Disadvantages of Mutual Funds Lack of Liquidity
Normally must be sold back to the fund Average to below average performance
Average Annual Returns 1989-1998 Actively managed stock funds 15.6% S&P 500 stock index 19.2%.
Fees and taxes can take a significant part of investor returns
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Disadvantages of Mutual Funds
Source: John Bogle, Common Sense on Mutual Funds: New Imperative for the Intelligent Investor, John Wiley & Sons, USA, 1999, p. 119)
Percentage of Actively Management Funds that failed to beat their benchmarks
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Number of Mutual Funds by Type
0500
1,0001,5002,0002,5003,0003,5004,0004,5005,000
EquityFunds
Bond Funds HybridFunds
MoneyMarket,Taxable
MoneyMarket,
Nontaxable
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Major Types of Mutual Funds Major Asset Classes
Money Market Funds Stock Funds Bond Funds
Specialty Funds Index Funds Exchange Traded Funds (ETFs) Balanced Funds Etc.
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Stock Funds: Payout Approach Income Funds
Goal: Current income Dividend income
Growth Funds Goal: Capital Appreciation
Higher-than-average revenue/earnings growth Aggressive/Maximum Growth Funds
Goal: Extreme Capital Appreciation Highly speculative, seeking large profits from
capital gains Often buy stocks of small, untested companies
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Stock Funds: Geographic Approach
Domestic Funds U.S. Equities Only
Global Funds U.S. and International Equities
International Funds International Equities Only
Country/Regional Funds Specific Country/Region of the World
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Stock Funds: Firm Size
Large-Cap(italization) Funds Capitalization $5 billion or more
Mid-Cap(italization) Funds Capitalization between $1 and $5 billion
Small-Cap(italization) Funds Capitalization $1 billion or less
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Stock Funds: Other
Sector Funds Particular industry such as biotechnology.
Socially Responsible Funds Companies that don’t produce harmful
products. Index Funds
Mirror an index, like the S&P 500
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Bond Funds: Yield
High-Yield (Junk) Bond Funds Corporate bonds that are higher risk and
higher yield. Index Bond Funds
Sampling of bonds included in an index.
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Bond Funds: Maturity
Long Term Bond Funds Maturities > 10 Years
Intermediate Term Bond Funds Maturities 5-10 Years
Short Term Bond Funds Maturities 1-5 Years
Note: Can be either Government or Corporate Bond Funds
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Bond Funds: Issuer
Corporate Bond Funds Treasury Bond Funds Municipal Bond Funds International Bond Funds
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Asset Allocation Funds Various asset classes, such as
stocks, and bonds, with precise amounts within each type
Rotate among stocks, bonds, and cash
Goal: Invest in the asset classes expected to perform the best over the coming period of time (‘Timing’)
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Balanced Funds Goal: Balance between Capital
Gains and Current Income Stocks and bonds
High-Grade Common Stocks (60-75%) Fixed Income Securities (25-40%)
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Mutual Funds: Other
Money Market Funds Goal: Higher return (after fees and
expenses) than traditional bank savings or checking accounts
Short-term liquid financial instruments such as commercial paper and government treasury bills
Access to high-yielding money market instruments without having to pay $100,000 denominations
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Mutual Funds: Other
Single Industry Specialty Funds Option Trading Commodity Funds Oil Drilling Cattle Funds Electronics Gold Chemicals Health
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Life-Cycle Funds
Change allocation depending on the age of the investor.
Reduce their allocation to stocks and increase their allocation to bonds
These funds seek to perform the asset allocation decision normally done by the investor and to reduce transaction costs as well.
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Mutual Funds: Returns and Costs
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Mutual Fund Returns
Capital Gains Market Value Appreciation Capital gains at the share level are not taxed
until you sell your mutual fund shares. Distributions
Interest, dividends, realized capital gains, etc. Taxable even if you do not sell any mutual fund
shares
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Mutual Fund Returns: Types
Qualified Stock Dividends Short-Term Capital Gains Long-Term Capital Gains Bond Dividends and Interest
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Costs of Mutual Funds
Explicit Costs Management Fees
Charged by the Advisor Percentage of average assets, e.g. .75%
12b-1 Fees To cover cost of advertising and marketing
Total Expense Ratio Fees as total percentage of assets
Custody (or Annual) Fees Brokerage house charges to hold mutual funds
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Costs of Mutual Funds
Implicit Costs: Taxes on Distributions Stock Dividends
15% or 5%. Short-Term Capital Gains
Marginal Tax Rate Long-Term Capital Gains
15% or 5%. Bond Dividends and Interest:
Marginal Tax Rate
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Costs of Mutual Funds
Hidden Costs: Transaction Costs Costs of the fund buying and selling
securities not included in other costs A good measure this is the turnover ratio, a
measure of trading activity during the period divided by the fund’s average net assets.
A turnover ratio of 50% means half the fund was bought and sold during the period
Turnover costs money and incurs taxes
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Costs of Mutual Funds
Other Hidden Costs: Account Transfer Fees
Charges for moving assets either into our out of an existing account
Account Maintenance Fees Fees for maintaining your account
Inactivity/Minimum Balance Fees Fees because you did not trade or failed to keep
a minimum balance in your account
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Front-, Back- and No Load Funds
Front-Load Funds Commissions charged when purchasing
shares. Investors pay a commission (sales charge) up
to 8.5% every time they purchase shares. This is sometimes called a front load. (Class A shares)
Average charge is 3-5% for which an investor can get purchase advice and explanations.
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Front-, Back- and No Load Funds
Back-Load Funds Commissions charged when selling shares. Contingent deferred sales load (back-end load)
(Class B shares). Charged upon withdrawal of funds (1-5%). Generally decreases on a sliding scale
depending on the number of years shares are held.
No-Load Funds Investors pay no sales charge up front. You deal directly with the fund with 800 numbers
or web sites, or from discount brokers.
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Open- versus Closed-End Funds Open-End Funds (91% of Funds).
Shares are issued and redeemed by the investment company at the request of investors.
Investors can buy and sell shares at the net asset value (NAV).
Closed-End Funds (7% of Funds). Shares are issued only when the fund is
organized. Only purchase shares only from another investor. Traded on exchanges and over-the-counter.
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Open-End Funds Investors buy and sell shares back to the
fund itself There is no limit on the number of shares the
fund can issue Net Asset Value (NAV)
Defined as the total market value of all securities held by the fund less liabilities, divided by the number of fund shares outstanding.
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Net Asset Value (NAV)
For most mutual funds, NAV is calculated at the close of trading each day.
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gOutstandin Shares
sLiabilitieAssetsNAV
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Net Asset Value Example Example: NAV
XYZ Mutual Fund owns assets totaling $10M and liabilities equal to $500,000 with 500,000 shares outstanding.
$19/share500,000
500,00010,000,000NAV
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Closed-End Funds
Closed-End Funds A fixed number of shares outstanding 100 Closed-end funds $8 billion market value
Investment Trusts Interest is an unmanaged pool of
investments Usually consist of corporate, government, or
municipal bonds
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Mutual Fund Prospectus
Mutual fund prospectus tells the funds objective and: A statement describing the risk factors. A description of the fund’s past performance. A statement describing the type of investments in the
fund’s portfolio. Information on how to open an account. Dividends, distributions and taxes. Information about the fund’s management. The process for investors to buy or sell shares. Services provided to investors. The turnover ratio of the fund’s investments.
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Mutual Fund Quotations Net asset value and asset value change. The fund family and fund name. Fund objective. Total return over various time periods. Ranking among funds with the same
objective. Sales load fees if any, or no load (NL). Annual expenses.
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