Making Mutual Fund Investments

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Making Mutual Fund Investments

• There are over 10,000 funds to pick from!

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Past performance?

• Past performance cannot be used to predict
  future returns. Your investment return and
  principal value on an investment will fluctuate,
  so your shares, when redeemed, may be worth more
  or less than their original cost.
• The Vanguard Group

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Making Mutual Fund Investments

• Selecting a Mutual Fund
• Match the fund's objectives with your investment
  objectives.
• Consider your tolerance for risk and your
  investment time horizon.
• Read the prospectus!

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What to do

• Bare Basics
• What are your financial needs?
• Examine a fund company
• Consider Funds costs
• Consider its volatility
• Examine Investment returns
• Build a diversified portfolio
• Review Funds policies.

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Money market accounts

• Investments in MMAs are not insured by the FDIC
  (Federal Deposit Insurance Corporation) or any
  governmental agency. It is therefore possible to
  lose money by investing in MMAs.

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Your Financial needs
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Fund Company

• Because you are investing hard-earned money it is
  important that the fund company you pick works
  very well.

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Some issues to consider

• 1. How forthright is the fund? Are they open and
  frank? Do they specifically address your
  questions? Do you feel that they are helpful?
  Does the fund fit your goals?
• Is there a disciplined approach to investing?
  Have they had any incidences where managers have
  been accused of deviating from stated investment
  policy?

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Issues contd

• Do they tout hot recent performance?
• What charges does the company impose for its
  services e.g. switching fees, withdrawal, etc. Do
  they have a good history of maintaining low
  costs?
• How experienced are the managers? Where did they
  work before? What is their track record?

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Funds costs

• The higher the costs the harder it is for a fund
  to generate a decent return.
• Some costs are avoidable e.g. sales commissions

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Impact of fees

• Suppose you invest 40,000 halfway in two
  accounts for 20 years and pay a 0.75 fee in one
  and a 2 fee in the other, how much would the
  difference in ending wealth be if the average
  annual return were 10.
• Ending value
• Lower fees 20,000(1.0925)20 117, 344
• Higher fees 20,000(1.08)20 93,219
• Fees 117,344 - 93,219 24,125
• ( Lower by 20.56!)

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Recall types of costs

• Sales Charges load and no-load funds.
• Expense ratio annual operating expenses
  management fees.
• 12b-1 fees funds marketing and distribution
• Stick to no-loads or low-load funds
• Trading costs frequent trading hazardous to
  wealth (turnover ratio)

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Consider Volatility

• Volatility is uncertainty! Compare a funds best
  and work years at the least.
• R- squared how much variability is explained by
  the benchmark index.
• Beta volatility relative to the market
• Beta different from 1, what type of fund is it
  large, small

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Volatility contd

• Duration Fixed income volatility measure.
• Recall inverse relationship between interest
  rates and bond values

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Investment returns

• After choosing fund type, evaluate funds in
  category
• Recent prospectus
• Returns relative to benchmark and also relative
  to peers.
• Morningstar Inc.
• Lipper Inc.

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Cumulative returns

• Do not be taken for a ride, cumulative returns
  can be deceiving!
• Example An 80 return over 10 years is simply
  about a 6 return per year.
• Learn how to use your math !!!!
• Look for returns after taxes what you actually
  get to keep.

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Reported returns Vs Individual return

• May be different because investment circumstances
  differ form one investor to another.
• Reported returns use a single cash flow invested
  at the beginning and compare that with the ending
  wealth.
• Need to know how to calculate your individual
  return.

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Diversify3
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Styles

• Growth-oriented stock funds invest in companies
  that sell above average (high P/E) due to strong
  market profit expectations
• Value-oriented stock funds invest in companies
  that are considered a bargain as the market
  expect below average performance.
• Blend funds invest in both (balanced).

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Bonds
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The Scales

• Vertical Aggregate Credit quality of issues in
  the fund
• Horizontal
• Short-term less than 5 years
• Intermediate term, 5-10 years
• Long-term, over 10 years

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Indexes
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Check the Funds Policies

• Are your interests protected? Excessive trading
  by shareholders or market timing
• Redemption fees
• Limits on trading
• Record keeping? Maintaining a cost basis for
  your taxable investments
• Turnover of assets

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Investment Concepts

• Indexing Some funds seek to mirror the
  performance of a market index such as the SP 500
  or the Dow Jones Industrial Average.
• Dollar cost averaging The idea is to invest a
  fixed amount on a regular interval into the same
  security, regardless of current market
  conditions.

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Investment ConceptsIndexing

• Index funds simply try to track the market
  averages and not to beat them
• Rationale Before costs, index investors earn the
  market return whatever that is in a given period
• Paradox Why have index funds performed better
  than actively managed funds?
• Low expenses
• Low turnover

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The Indexing Advantage
Source Lipper Inc.
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Investment ConceptsDollar-Cost Averaging

• Invest fixed amount on a regular basis helps
  manage through ups and downs.
• Used widely by individual investors
• Examples are employer sponsored accounts.

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Investment ConceptsDollar-Cost Averaging

• Suppose individual invests 100 per month in 3
  market scenarios.
• A shares increase by 1 each month starting at
  10.
• B shares fall by 1 each month starting at 18.
• C shares decline from 10 to 5 then rise back
  to 10.

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Dollar-Cost Averaging
Insert Table 18-5 here.
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Investment ConceptsDollar-Cost Averaging

• A fluctuating market is more desirable than an
  increasing market
• No guarantee of a profit if you sell at bottom of
  a market but continual investment enhances
  terminal wealth.
• DCA fails in
• Declining market
• Selling at the bottom instead of buying.

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• Refer to Exhibit 13.8 concerning mutual fund
  facts every investor should know.

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Mutual Fund Performance

• Returns consist of
• 1) dividend/interest income earned by the fund
  assets
• 2) realized capital gains distributions from sale
  of assets within the fund
• 3) change in mutual fund's share price.
• Past performance reveals success of fund managers
  but does not guarantee future returns!

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THE END!