1Based on Personal Financial Planning by Gitman and Joehnk, Thompson, 11e, 2008. Slides by Dorla Evans, FIN 100, The University of Alabama in Huntsville.

Chapter 13

Mutual Funds

2

What we know now?

The higher the risk, the higher the return the investor should expect.

There are many sources of risk. Portfolio diversification reduces risk but does

not eliminate it. Investing over long time periods reduces risk. We cannot out-perform the market on a risk-

adjusted basis because the market is informationally efficient.

3

So What Do We Do?

Determine risk preference

Decide on asset allocation

Create a portfolio

Hold for the long term

4

Create portfolio through mutual funds

Pool money from investors with similar goals

5

Mutual Fund Hire a management

company to run the fund

Invests in numerous securities

Sends statements

6

What Really Happens

We contact mutual fund to invest

We buy shares in the fund:

$2,000/$100 = 20 shares

7

Ways of Making Money With Mutual Funds

Shares increase in value (appreciation) as stocks/bonds in mutual fund increase in value

Dividends or interest are reinvested in more shares

8

Why Invest in Mutual Funds?

Liquidity

Minimal transaction costs

Convenience

Instant diversification

Level the playing field between professional and individual investors

Share administrative expenses

9

Disadvantages of Mutual Fund Investing

Lower-than-market performance

Costs

10

The Costs of Mutual Funds

Load funds -- sales commissions charged to the investor when purchasing fund shares

Management fees and expenses -- fees associated with the operation of the company

12b-1 fees -- fees charged to cover the fund’s cost of advertisement and marketing

11

Types of Funds

Open-end

Closed-end

Unit investment trust (UIT)

Exchange traded fund (ETF)

Real-estate investment trust (REIT)

12

Objectives of Mutual Funds

Money market mutual funds

Stock mutual funds

Bond funds

Asset allocation funds

13

Stock Mutual Funds

Aggressive growth funds Small-company growth funds Growth funds Growth-and-income funds Sector funds Index funds International funds Emerging markets funds

14

Facts About Index Funds Outperform 2/3 of actively managed funds

For 10 years ending 1998 index funds outperformed average manager by 3.5 percentage points

Last 30 years $10K investment: Index fund -- $311K (costs .2%) Gen. equity fund -- $172K (trans. costs .75% to 1% of

assets; admin costs 1.5%)

15

Services Offered by Mutual Funds Automatic investment and withdrawal plans Automatic reinvestment of interest,

dividends, and capital gains Wiring and funds express options Phone/Internet switching Easy establishment of retirement plans Check writing Bookkeeping and help with taxes

16

Buying a Mutual Fund

Step 1: Determine your risk preferences

Step 2: Determine your asset allocation

Step 3: Identify family of funds that meet your objectives

Step 4: Evaluate the funds.

17

Steps 1 & 2: Determine Your Risk Preferences and Asset Allocation

Determine your time horizon and risk tolerance

Determine your asset allocation preferences

18

Step 3: Identify Funds That Meet Your Objectives

Look to third-party publications Go to Morningstar’s web site Use screening tool to find smaller

number of funds to study Look for no-load, open-end, low-fee

funds Find a family of funds to manage your

asset allocation

19

Step 4: Evaluate the Fund

Read the prospectus!!!

Compare returns, risk, turnover, and costs of funds with the same objective

Evaluate the fund’s long-term performance

Look at returns in both up and down markets

20

Sources of Information

Wall Street Journal Forbes or Business Week Kiplinger’s Personal Finance Smart Money or Consumer Reports Wiesenberger Investment Companies

Service Morningstar Mutual Funds

21

Making the Purchase

Buying through a broker

Buying directly from the mutual fund

22

Questions?