Chapter 14: Mutual Funds & Exchange Traded Funds: An Easy Way to Diversify

Advantages of mutual funds

diversification, professional management, minimal transaction costs, liquidity, flexibility, service, avoidance of bad brokers

Disadvantages of Mutual Funds

Lower-than-market performance, Costs, Risks, You can't diversity away a market crash, Taxes

Mutual Fund

An investment fund that raises funds from investors, pools the money, and invests it in stocks, bonds, and other investments. Each investor owns a share of the fund proportionate to the amount of his or her investment

Amentals

- mutual fund pools money from investors with similar financial goals

- investing in a diversified portfolio that's professionally managed according to set goals

- investment objectives are clearly stated

Investment Company

A firm that invests the pooled money of a number of investors in return for a fee

Open-end Mutual Funds

A mutual fund that has the ability to issue as many shares as investors want. The value of all the investments that the fund holds determines how much each share in the mutual fund is worth

Net Asset Value (NAV)

The dollar value of a share in a mutual fund. It's the value of the fund's holdings (minus any debt) divided by the number of shares outstanding

Closed-End Mutual Fund

A mutual fund that can't issue new shares. These funds raise money only once by issuing a fixed number of shares, and after that, the shares can be traded between investors. The value of each share is determined both by the value of the investments the fund holds and by investor demand for shares in the fund

Exchange Traded Fund (ETF)

A hybrid of a mutual fund and an individually traded stock or bond that trades on an exchange just as individual securities do and that can be bought and sold throughout the trading day

REIT

Real Estate Investment Trusts

Advantages of ETFs

- trade on an exchange just as individual securities do and can be bought and sold throughout the trading day

- can be sold short or bought on margin

- allow you to take an instant position in a sector or country that you may not otherwise have access to

- have very low annual expenses

- are more tax efficient than most mutual funds

Disadvantages of ETFs

- commissions

- don't necessarily trade at their NAVs

- ETFs can be more expensive than typical mutual funds. That's because you incur brokerage costs each time you buy or sell ETF shares

Unit Investment Trust

A fixed pool of securities, generally municipal bonds, in which each share represents a proportionate ownership interest in that pool. The bonds are purchased and then held until maturity, at which time the trust is dissolved.

Real Estate Investment Trust

An investment vehicle similar to a mutual fund that specializes in real estate investments, such as shopping centers or rental property, or that makes real estate loans.

Hedge Fund

An investment fund that is private, largely unregulated, and very risky and that charges very high fees and only allows wealthy investors to invest.

Load

a sales commission charged on a mutual fund

Load Fund

A mutual fund on which a load or sales commission is charged

Back-End Load

A commission that's charged only when the investor liquidates his or her holdings

No-Load Fund

a mutual fund that doesn't charge a commission

Expense Ratio

The ratio of a mutual fund's expenses to its total assets

Turnover Ratio or Rate

A measure of the level of a fund's trading activity, indicating what percentage of the fund's investments are turned over during the year

12b-1 Fee

An annual fee, generally ranging from 0.25 to 0.75 % of a fund's assets, that the mutual fund charges its shareholders for marketing costs

Money Market Mutual Fund

A mutual fund that invests in Treasury bills, certificates of deposit, commercial paper, and other short-term notes, generally with a maturity of less than 30 days

Tax-Exempt Money Market Mutual Fund

A money market mutual fund that invests only in a very short-term municipal debt

Government Securities Money Market Mutual Fund

A money market mutual fund that invests solely in U.S. government securities in order to avoid any risk whatsoever.

Stock fund

a mutual fund that invests primarily in common stock

Aggressive Growth Funds

Stock fund that tries to maximize capital appreciation while ignoring income (go for stocks whose prices rise dramatically, even with small dividends)

Small Company Growth Funds

A type of stock fund that tries to maximize the capital appreciation however only through small companies

*purpose is to uncover and invest in undiscovered companies with unlimited future growth

*has a great deal of risk involved

Growth Funds

mutual funds that focus on stocks that have potential for above-average growth. Small differences between these and aggressive growth funds except for growth funds pay attention to stocks with more dividends. and less risky stocks.

Growth-and-Income Funds

General category of funds that invest in a portfolio with a steady stream of income with the addition of having the potential for increasing value

Sector Funds

mutual funds that focus on a specific industry or sector, such as technology stocks. At least 65% of its assets in securities are invested in said industry.

Index Funds

mutual funds that attempt to mirror the movements of an existing stock index

International Funds

invest strictly in foreign securities

Balanced Mutual Funds

A mutual fund that tries to "balance" the objectives of long-term growth, income, and stability. To do this, these funds invest in a mix of common stock and bonds, as well as preferred stock in some cases. Aimed at those needing income to live on and moderate stability in their investment

Asset Allocation Fund

A mutual fund that invests in a mix of stocks, bonds, and money market securities

Life Cycle Fund

A mutual fund that tries to tailor its holdings to the investor's individual characteristics, such as age and risk tolerance.

Target Retirement Fund

A mutual fund professionally managed for an investor's stage of retirement planning, with the investments in the fund automatically growing more conservative as the investor's retirement date nears

Bond Fund

A mutual fund that invests primarily in bonds

U.S. Govt Bond Funds

Invests in securities issued by the federal government or its agencies

Government National Mortgage Association Bond Fund

Funds holding pools of individual residential mortgages that have been packaged by the GNMA

Municipal Bond Funds

mutual funds that invest in municipal bonds. Interest is generally exempt from federal taxes

Corporate Bond Funds

mutual funds that focus on bonds issued by high-quality firms that tend to have a low degree of default risk

Short-term Bond Maturity

1 to 5 years to maturity

Intermediate-term Bond Maturity

5 to 10 years to maturity

Long-term Bond Maturity

10 to 30 years to maturity

Mutual Fund Services

-Automatic investment and withdrawal plans

-Automatic reinvestment of interest, dividends, and capital gains

-Wiring and funds express options

-Online and phone switching

-Easy establishment of retirement plans

-Check writing

-Bookkeeping and help with taxes

Buying a Mutual Fund

Step 1: Determining Your Goals

Step 2: Meeting Your Objectives

Step 3: Selecting the Fund

Step 4: Making the Purchase

Step 1: Determining Your Goals

- Goals and time horizon

- Why are you investing?

- Tax-deferred investments?

- Risk tolerance

Step 2: Meeting Your Objectives

- Look at classifications and objectives

Step 3: Selecting the Fund

- Evaluate past performance and scrutinize the costs

- Make sure it meets your objectives

Step 4: Making the Purchase

- Buy direct -- use phone or Internet

- Buy through a mutual fund "supermarket" -- such as Fidelity or Charles Schwab & Co.

Mutual Fund Prospectus

A description of the mutual fund, including the fund's objectives and risks, its historical performance, its expenses, the manager's history, and other information.