matual fund

INVESTING IN MUTUAL FUNDS

Topic 11

A. POOLED DIVERSIFICATION

1. Professional Money Managers 2. Combines the Funds of many people

with similar investment goals 3. Receive shares of stock in the

mutual fund; a pooled common investment.

4. An indirect investment

B. ATTRACTIONS AND B. ATTRACTIONS AND DRAWBACKS OF MUTUAL DRAWBACKS OF MUTUAL FUND OWNERSHIPFUND OWNERSHIP 1. Diversification 2. Full-time Professional Management 3. Modest Capital Investment 4. Services offered

a. Automatic reinvestment of dividends b. Withdrawal plans c. Exchange privileges d. Check writing privileges

B. ATTRACTIONS AND B. ATTRACTIONS AND DRAWBACKS OF MUTUAL DRAWBACKS OF MUTUAL FUND OWNERSHIPFUND OWNERSHIP 5. Convenience

a. Easy to acquire b. Paperwork and record keeping c. Prices are widely quoted

6. Lack of liquidity a. Normally must be sold back to the fund b. No brokerage commissions

7. Consistently average to below average performance

C. ESSENTIAL C. ESSENTIAL CHARACTERISTICSCHARACTERISTICS

1. Open-end Funds a. Investors buy and sell shares back to the

fund itself b. There is no limit on the number of shares the

fund can issue c. 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.

NET ASSET VALUE EXAMPLENET ASSET VALUE EXAMPLE

Example: NAV XYZ Mutual Fund owns assets totaling $10M

and liabilities equal to $500,000 with 500,000 shares outstanding

Therefore, NAV is: $10,000,000 - $500,000 / 500,000

$19/share$19/share

C. ESSENTIAL C. ESSENTIAL CHARACTERISTICS CHARACTERISTICS (CONTINUED)(CONTINUED)

2. Closed-end Funds a. A fixed number of shares outstanding b. 100 Closed-end funds c. $8 billion market value

3. Investment Trusts a. Interest is an unmanaged pool of

investments b. Usually consist of corporate, government, or

municipal bonds

C. ESSENTIAL C. ESSENTIAL CHARACTERISTICS CHARACTERISTICS (CONTINUED)(CONTINUED)

4. Load or No Load a. Load Fund

Charges a commission when shares are bought (7 - 8 1/2% or more)

b. No Load FundNo sales charges are levied

5. Other fees and Costs a. Professional Management Fee

.25 to 1.75 percent of the average dollar amount of assets under management

D. TYPES OF FUNDS (EQUITY)D. TYPES OF FUNDS (EQUITY)

1. Growth Goal is capital appreciation

2. Maximum Growth Highly speculative, seeking large profits from

capital gainsa. Often buy stocks of small, unseasoned companies

b. Highly speculative

D. TYPES OF FUNDS D. TYPES OF FUNDS (CONTINUED)(CONTINUED)

3. Income CURRENT income is main objective

a. Interest incomeb. Dividend income

4. Balanced Funds Objective is to earn both capital gains and

current incomea. High-grade common stocks (60 - 75%)

b. Fixed income securities (25 - 40%)


5. Small Company Invest in small companies that usually have

sales of $100 million or less.6. International Can invest in one region or area of the world Can invest in specific country


Bond Funds Objective is to invest in bonds

a. Income is primary objectiveb. Two advantages

Liquidity Diversification


6. Money Market Funds Offers the individual investor access to high-

yielding money market instruments without having to pay $100,000 denominationsa. Bank CD’sb. Treasury Billsc. Commercial Paper


7. Dual Funds Closed-end Funds with two types of shares

a. INCOME shares (Senior) which receive two times income as Junior

b. CAPITAL shares (Junior) which receive two times the capital gains as Senior


8. Specialty Funds - Single Industry a. Option trading b. Commodity funds c. Oil drilling d. Cattle funds e. Electronics f. Gold g. Chemicals h. Health

E. SPECIAL SERVICESE. SPECIAL SERVICES

1. Saving Plans Investor adds funds on a regular basis

2. Automatic Reinvestment Plans Dividends and capital gains are reinvested in

additional shares 3. Regular Income

Through withdrawal plans, the investor can receive periodic repayment or incomeShares or Dollars

E. SPECIAL SERVICES E. SPECIAL SERVICES (CONTINUED)(CONTINUED)

4. Conversion Privileges Allows the investor the right to switch from one

fund to anothera. Must confine switches within the same family of funds

b. Usually no transfer charges

E. SPECIAL SERVICES E. SPECIAL SERVICES (CONTINUED)(CONTINUED)

5. Check Writing Privileges a. Shareholders have the right to write checks

drawn on the Mutual Fund account b. Normally checks must be written for at least

$500 c. Almost all Money Funds have this privilege

F. RISKF. RISK

Because Mutual Funds are so well diversified (typically), the inherent risk is similar to that in the Market

However, Specialty Fund risk can vary significantly from overall Market risk

5 30 Assets

Systematic Market

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ANALYZING MUTUAL FUNDSANALYZING MUTUAL FUNDS

Assessment of your risk tolerance Importance of diversification Should hold six mutual funds Should be able to earn 16% plus with a beta

equivalent to 1.0 or slightly less

MUTUAL FUND ANALYSIS:MUTUAL FUND ANALYSIS:

Style Analysis: Style analysis identifies the process of investing by fund managers that leads them to pick certain kinds of securities.

Three factors of style analysis: Growth Value Company Size

MUTUAL FUND ANALYSIS:MUTUAL FUND ANALYSIS:

Growth Managers buy stocks in companies whose earnings are growing rapidly.

Value Managers are bargain hunters seeking stocks with low prices compared to intrinsic value.

Company Size Managers specialize in small companies or large cos.

MUTUAL FUND STYLE MUTUAL FUND STYLE ANALYSIS:ANALYSIS:

Style determines 85-90% of a fund portfolio’s return.

The technique looks at the way funds perform on a monthly basis against one of 12 different indexes. The mix of indexes that are most highly correlated determines the style of the mutual fund manager.


The mutual fund universe can be divided into six basic styles: Small cap growth funds Large cap growth funds Small cap value Large cap value Foreign funds Fixed income funds


Source of Information:Advisor SoftwareStyle Data1-800-738-6369http://www.advisorsw.com

MUTUAL FUND ANNUAL MUTUAL FUND ANNUAL REPORTSREPORTS Two Reports a Year:Two Reports a Year: Mutual funds typically issue two

financial reports a year - the semiannual report, which is often dated June 30 or April 30, and the year-end or annual report, which is often dated December 31 or October 31.

Shareholder Letter:Shareholder Letter: A shareholder letter is usually written by the fund’s president or investment manager and reviews the fund’s investment objectives and performance for the current period.

Top 10:Top 10: By looking at a mutual fund’s top 10 holdings, you will get a sense of the type of investments in the portfolio and the degree to which the fund meets your investment objectives. Similarly, study the industry composition of the portfolio - the percent of the fund’s asset that is invested in a particular industry.

MUTUAL FUND ANNUAL MUTUAL FUND ANNUAL REPORTSREPORTS

Investment Portfolio: Investment Portfolio: An investment portfolio comprises the assets (securities) held within a mutual fund.

Portfolio Turnover:Portfolio Turnover: Portfolio turnover is the percentage of the portfolio’s investment that are bought and sold in one year. A fund with a portfolio turnover rate of 100 percent means they effectively bought and sold every security in the portfolio. High portfolio turnover increases transaction expenses and often reduces your rate of return.

Charts and Graphs:Charts and Graphs: Many mutual fund reports include charts and graphs. A line graph may compare the growth of a $10,000 investment in the fund to the growth of similar investments over five years, ten years, or over the life of the fund. Pie charts are used to show the % of each type of investment in the fund: C.S., bonds, and cash.

MUTUAL FUND ANNUAL MUTUAL FUND ANNUAL REPORTSREPORTS Portfolio:Portfolio: Some mutual fund financial reports

include a more in-depth discussion of the fund’s performance for the period than the shareholder’s letter.

Statement of Assets and Liabilities:Statement of Assets and Liabilities: A mutual fund’s statement of assets and liabilities reflects the fund’s financial position at the stock or bond market’s close on the date of the report. Assets typically include investments that are valued at market on the financial statement date. Other assets include collateral held for securities loaned and receivables. Two examples are dividends and interest income receivable, which represent income earned by the fund but not yet collected in cash. Liabilities primarily represent amounts the fund owes for the purchase of new securities.

MUTUAL FUND ANNUAL MUTUAL FUND ANNUAL REPORTSREPORTS Footnotes to the Financial Statements:Footnotes to the Financial Statements: Mutual

fund financial reports include footnotes similar to those found in other annual reports. Footnotes include significant accounting policies, and related party and affiliate transactions.

Significant Accounting Policies:Significant Accounting Policies: Related party and affiliate transactions typically include three types of transactions. The first occurs when payment of fees is made to portfolio managers and financial advisors. The second occurs when a mutual fund accumulates an ownership stake of a least 5% of the company. The third occurs when one mutual fund sells some of its investments to another mutual fund sponsored by the same mutual fund family.

DEADLY MUTUAL FUND DEADLY MUTUAL FUND MYTHS - THE MYTHS - THE CONVENTIONAL CONVENTIONAL WISDOM MYTHWISDOM MYTH 1. The Conventional Wisdom Myth

This is the number one mistake most investors make. Investors look at historic trends reported by Forbes, Kiplinger’s Business Week and others tend to recommend funds that have already made big gains rather than identify funds that are positioned to make profits in the future.

THE DIVERSIFICATION MYTHTHE DIVERSIFICATION MYTH

2. If you own at least 10 different mutual funds you’ll have a diversified portfolio. Owning 10 mutual funds won’t assure you of

anything but a lot of work trying to stay on top of them all. In fact, you can have a well diversified portfolio with just 4 to 6 funds or you can have a portfolio of 15 funds with very little diversification.

THE MOMENTUM MYTHTHE MOMENTUM MYTH

3. The easiest way to beat the market is to buy last year’s top-performing funds. The fact is that last year’s best funds are just as

likely to be this year’s dogs. Blindly following this strategy is very dangerous for most investors. The very top-performing funds are usually those that took a lot of risk and happened to bet on the right market sector at the right time.

THE FIVE-STAR MYTHTHE FIVE-STAR MYTH

4. The best funds to buy are those rated 4 or 5 Stars by MorningstarMorningstar. The star system tells you which funds were

good, not which ones will be good. Even MorningstarMorningstar will tell you that their ratings are a measure of past (risk-adjusted) performance, not the potential for future profits. Relying on statistical ratings is no substitute for a thorough examination and analysis of what a fund is doing today.

THE MARKET TIMING MYTHTHE MARKET TIMING MYTH

5. The safest strategy is to move everything into money market funds when the market is declining and switch everything back into stock funds when the market is rising. This is a loser’s game. It has been proven over

and over that investors are incapable of timing the market or identifying major bull or bear markets.

THE LONG-TERM THE LONG-TERM PERFORMANCE MYTHPERFORMANCE MYTH 6. The best measure of a fund’s quality is its

long-term performance. There is a fair amount of truth to this statement,

but too many investors follow some broker’s advice to “buy this fund, it has a great 10-year record,” without asking some key questions. Who earned that record? Is the manager responsible for its returns still at the helm? If not, the record could be meaningless.

THE NEW FUND MYTHTHE NEW FUND MYTH

7. You should wait until a fund has at least a 3-year track record before investing.The fact is that brand new funds often

enjoy superior gains. New funds from top fund families often show explosive gains in their rookie year. Montgomery Small Montgomery Small Cap Cap was up 98.8% in 1991, OakmarkOakmark was up 48.9% in 1992, DFA Pacific Rim Small DFA Pacific Rim Small Company Company was up 92.6% in 1993, and JanusJanus OlympusOlympus was up 30% the first 9 months of 1996.

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