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MUTUAL FUNDS |
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Overview As the name suggests, a mutual fund is for investors with mutual goals. The investment company that offers the mutual fund pools together money from many investors and invests on their behalf. Mutual funds allow you to spread your money among different types of investments with the help of a team of financial professionals. Even if you only have a small amount to invest, you can find a mutual fund that meets your needs. A mutual fund doesn’t necessarily invest in one type of investment. For example, balanced funds invest in a mixture of stocks and bonds. Mutual fund investors have a wide range of choices such as:
Mutual funds also utilize different styles of investing. As an example, a fund might use the growth or value style of investing.
Open-End Funds As a new investor, you’ll probably be looking at open-end mutual funds, which are the most common. With an open-end mutual fund, you can buy or sell shares at any time, but you’ll receive the net asset value (NAV) for each share. NAV reflects the actual value of all of the assets in the fund’s portfolio. NAV is recalculated at 4:00 p.m. EST on a daily basis and may be higher or lower than the amount you paid per share. The fund manager decides which investments to buy and sell. The parameters for these buy and sell decisions must be consistent with the fund’s investment objective, which can be found in the prospectus. What the prospectus tells you about a mutual fund Much like the syllabus for a course you are taking, the prospectus gives you important information about a mutual fund. The prospectus is a legal document that tells you all of the following:
Unfortunately, no prospectus can tell you if your investment will perform as well as you hope it will.
Fees Load versus no-load funds With some mutual funds, you will pay a sales charge. Generally, a mutual fund you invest in through a broker will have a sales charge known as a load. A fund with no sales charge is called a no-load fund. There are several types of loads:
Other load funds charge what is known as a 12b-1 fee, which represents a charge for marketing expenses and distribution. 12b-1 fees are used to compensate the broker who sold you the fund. Expense ratios The mutual fund company that doesn’t charge a load makes its money on annual fees and operating expenses. Fees are disclosed in the mutual fund prospectus. The expense ratio is the ratio of expenses to assets. A lower expense ratio means you will keep more of the return on your investment. A very helpful tool is the NASD Mutual Fund Expense Analyzer, apps.nasd.com/investor_Information/ea/nasd/mfetf.aspx. Expenses make a big difference. You’ll have almost $20,000 more in 20 years if you invest $25,000 in a fund with a 0.3 percent expense ratio versus one that has a 1.3 percent expense ratio, assuming an 8 percent return and all other factors being equal.
Types of Funds Actively-managed funds Whether you’re a conservative investor or someone who is willing to invest aggressively, you’ll find a mutual fund that’s right for you. Actively-managed funds have two broad objectives:
To achieve growth or income or a combination of both, the mutual fund’s portfolio manager utilizes a particular investment strategy. Mutual fund managers put their own imprint on investing for growth or income. For example, aggressive growth fund managers take more risks to achieve that goal. Fund managers aiming for income may invest in stocks or bonds, or some mixture of the two. Another fund manager might generate income for shareholders by focusing on stocks that pay high dividends. International funds Global or international funds invest in foreign companies. They are usually riskier than funds that invest in companies doing business in the United States. When you invest internationally, you face the following risks:
Index Funds Index funds are mutual funds that do not try to predict which investments will go up in value. Index funds create a portfolio that mimics the performance of a particular market index. For example, an index fund may be comprised of the same stocks that make up the Dow Jones Industrial Average. The Dow is a collection of 30 blue chip stocks and is one of the best-known indicators of how the market is performing. Index funds may duplicate the stocks, bonds or investments making up other indices. As examples, there are indices for:
Index funds are built on the assumption that you will succeed as an investor if you match the performance of the market as a whole or in one particular area. An index fund keeps pace with the market index on which it is based. In contrast, actively-managed funds attempt to outperform the market as a whole or in one particular area. An index fund almost always has lower expenses than a mutual fund that is actively managed. Exchange-Traded Funds (ETF) An Exchange Traded Fund (ETF) is a similar investment that also tries to match the performance of a market index or benchmark. It might build a portfolio based on a particular style of investing or a certain type of investment. For example, you can buy an ETF that seeks investment results that correspond to the performance of U.S. large-cap value stocks. Another ETF might build a portfolio that is tied to a bond index. With each share of an index fund or ETF, you build diversity into your portfolio. Here’s how an ETF differs from an index fund:
Both index funds and ETFs offer tax savings, because they make fewer trades than an actively-managed fund.
Tips & Common Mistakes Tip: Do your homework If you decide to invest in an actively-managed fund, see how it compares to its benchmark. For example, the Russell 1000 Growth Index is the benchmark for many growth funds. The Russell 1000 is the collective performance of 1,000 growth stocks. You might see mutual funds advertise their Morningstar Rating.ä Morningstar (www.morningstar.com) is an investment research firm that provides ratings of mutual funds. Each fund with at least a three-year history receives a rating from a high of five stars to a low of one star. The top 10 percent of funds in a particular category receive five stars. Lipper (www.lipperweb.com) is another company that rates mutual funds. Common mistake: Buying high performers New investors sometimes make the mistake of chasing the hot mutual fund that performed well last year and that’s no guarantee of success. Sometimes, the top-performing mutual funds attract too many investment dollars and that makes it difficult for the portfolio manager to duplicate last year’s success. While past performance is not indicative of how your fund will do in the future, it is still a way to evaluate a mutual fund or some other investment. Tip: Remember your preferences Even though mutual funds offer you more diversification than individual stocks, bonds, or other investments, economic conditions and other factors may send them spiraling downward. Make sure you fully understand the risks you’re taking with your money. The mutual fund you invest in should be consistent with your investment goals, time horizon, and risk tolerance. To diversify your nest egg, invest in a variety of funds that use different investment strategies. Although you may not achieve the highest rate of return, you’ll couch your bets among mutual funds that will achieve different levels of success. Diversity reduces the volatility of your investments.
Getting Started Most investment companies offer a family of mutual funds of almost every description that are suitable for just about every type of investor. There are several ways to start investing in mutual funds:
If you invest on your own, here’s what you need to do:
If you need assistance in selecting the fund that’s right for your particular situation, you should consider using a broker. Whether you use a broker or not, always make sure you understand what fees, charges and expenses you’ll pay. Make sure your broker is licensed and has not been disciplined for misconduct. You should check with the securities regulator in your state and NASD. Either visit NASD's BrokerCheck website or call its toll-free BrokerCheck hotline (1-800-289-9999). You can investigate the background of registered investment advisers online at www.advisorinfo.sec.gov. A great way to start investing in mutual funds is through an automatic investment plan, especially if you don’t have much of a nest egg. Many mutual funds waive the minimum investment requirement if you agree to automatically invest a small amount each month. For example, you could have $50 deducted each month from your checking account and invested in the mutual fund of your choosing.
FAQs What type of mutual fund is right for me? The mutual fund that’s right for you is one that does the following:
You can invest more aggressively if you have a longer time horizon, because you have more time to recover from the inevitable ups and downs of the market. What is a socially-responsible fund? Socially-responsible funds allow you to invest in a manner that’s consistent with your values. These funds won’t invest in certain types of companies. For example, certain socially-responsible funds refuse to invest in companies that sell cigarettes. Your perception of a socially-responsible investment might be different from someone else’s. Whereas you might want to stay away from companies that are not environmentally-friendly, another investor might shy away from corporations that profit from gambling or alcohol. The mutual fund’s prospectus will tell you what ideals drive investment decisions. The socially-responsible fund’s Web site will tell you some of its recent holdings. The Morningstar.com Web site will give you the names of socially-responsible mutual funds you may wish to consider. Remember, though, that investing in companies that share your values doesn’t necessarily mean you’ll make money on your investment.
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