Mutual Funds forLong Term Goals (IRAs)

Financial Planning for WomenPowerPoint by Tiffany Smith

Students from Advanced Family Finance Class:

Christine Ballard, AddieAnn Hancock, Danielle Walker, Jodi Miller

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Summer FPW

• June 13: Estate Planning. Rock Allen, attorney

• July 11:: Five Timeless Principles of Investing. Jeff Salisbury, fee-only investment advisor

• August 8: Choosing and Working with a Financial Advisor. Allen Marler, CFP

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Overview

• Invest in stocks for the long run

• IRA review

• What is a mutual fund?

• How to choose a mutual fund

• Specific MF recommendations based on students’ research

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Why Stocks for the Long Run?

• Higher risk = higher potential returns– Risk = volatility (annual returns = -50%-+50%)

• Historic average annual rates of return– Stocks 10%– Bonds 6%– Cash equivalents (CDs) 3%

• Inflation averages 3.1%/year

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Individual Retirement Accounts

• Tax-advantaged investing– the account is not taxed while it is growing– When $ is withdrawn in retirement

• Traditional IRA withdrawals are taxed• Roth IRA withdrawals are tax-free

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Traditional Vs. Roth IRA

• Contributions may be tax-deductible– Depends on income &

employer sponsored plan

• $ is taxed when withdrawn at retirement

• Must start withdrawals at 70 ½ (spend during lifetime)

• Contributions are not tax-deductible

• $ is not taxed when withdrawn at retirement

• Do not have to start withdrawals at age 70 ½

• Can bequeath to heirs

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Questions?

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What is a Mutual Fund?

• A company that pools money from many investors to buy a wide variety of securities (stocks, bonds, etc.)

• Automatic diversification – Each investor owns a pro-rata share of all

investments in the portfolio

• Professional management

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Why Mutual Funds?

• Diversification– Own a piece of many companies– For a small $ amount you gain a great deal

of diversification

• Easy to match your investment objective

• Convenient to purchase and sell

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Load vs. No-Load

• Load funds are sold by financial sales people who charge commissions – ~5% of every $, every time you invest

• No-load (no commission) funds– Sold directly to investor (no salesperson)

• web sites• 800 phone number• mail

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Index vs. Actively Managed Funds

Index• Tracks a market index

– S&P 500– DJ Wilshire 5000

• Fees are low• Low turnover rate• Investment returns

mirror the index

Actively Managed• Higher management

fees• Higher turnover rate• it is uncommon for the

return to be higher than its index for extended periods

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How to Choose a Mutual Fund

• Investment Objective

• Diversification: more is better

• No-Load

• Low expense ratio

• Minimum Initial/Subsequent Investment– Automatic investment plan

• Independent ratings

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Initial/Subsequent Investment

• Most funds require a large initial investment (i.e., $1,000 – 3,000)

• Lower subsequent minimum investments once in the fund ($50-250)

• A few funds allow you to bypass initial investment if you set up automatic investment plan (AIP)

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Expenses/Custodial Fees

• Funds charge investors fees and expenses.

• A fund with high costs must perform better than a low-cost fund to generate the same returns.

• Small differences in fees can translate into large differences in returns over time.

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MF Expense Analyzer

• Compares cost of owning a fund over time based on the fund’s expense ratio

• National Association of Securities Dealers (NASD)

• Compare 3 funds at a time

• http://apps.nasd.com/investor_Information/ea/nasd/mfetf.aspx

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Expense Example

• Invest $10,000 for 20 years in a fund w/ 10% annual return– 1.5% expense ratio; grows to $49,725– 0.5% expense ratio; grows to $60,858

• 18% more!

– Average expense ratio for stock MFs = 1.5%

– Index funds charge very low expenses

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Questions?

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Funds Chosen by Adv. FF Class

• Index– Vanguard Total Stock

Market Index

• Target Retirement Date– Vanguard 2045 Fund– T. Rowe Price

• Actively managed– Homestead Value

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Target Retirement Date Funds

• Objective: seek capital appreciation through diversification– managed according to your stage in life– become more conservative over time

• Automatic rebalancing

• Invest in existing funds from same family – U.S. & international stocks & bonds

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Target Date Retirement

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Vanguard Target Retirement

Inception date: 2003– underlying funds have much longer track

record

• Expense Ratio: 0.21%

• 12% return since inception

• Expect 8-10% returns over long run

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Target Retirement Funds

• 2045: For people in their 20s who plan to retire between 2040 & 2049– 94% invested in U.S. & international stocks

• Other funds for earlier retirement dates: – 2035: 77% stocks/23% bonds– 2025: 59% stocks/41% bonds– 2015: 49% stocks/48% bonds/3% inflation-protected– 2005: 33% stocks/49% bonds/18% inflation-protected

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Underlying Vanguard Funds (asset allocation) 2045 Fund

• Stocks

– Total Stock Market Index Fund 70.7%

– European Stock Index Fund 11.8%

– Pacific Stock Index Fund 11.6%

• BondsTotal Bond Market Index Fund 5.9%

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Vanguard Target Retirement

• Initial Investment:

$3,000 in IRA or non-IRA

• Subsequent Investment:

$100 or $50 w/ AIP

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T. Rowe Price Target Date

Inception date: 2005– underlying funds have much longer track

record

• Expense Ratio: 0.76%

• 11% return since inception

• Expect 8-10% returns over long run

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T. Rowe Price Target Date

• Initial Investment:– $2,500 non-IRA– $1,000 in IRA

• Subsequent Investment: – $100 or $50 w/ AIP

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Vanguard Total Stock Market Index

• Objective – Track the MSCI index of all U.S. stocks

• Minimum initial investment = $3,000

• Minimum Subsequent =$100 /$50 (AIP)

• 0.19% Expense Ratio

• 8.92% Average return for 10 years

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Vanguard Total Stock Market Index

• Asset Allocation– Stocks 98.3%– Cash 1.0%– Other 0.7%

• Suitable for long term investors seeking maximum returns & willing to endure market volatility – Remember 2000-2003?

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Homestead Value Fund

• Actively managed

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Objectives

• Low Volatility– Diversification– Low Turnover (13%)– Hold stocks for

average of 10 years

• Low Risk– Solid industries and

underlying companies– Sharpe Ratio of 1.46

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Investment Requirements

• Amazing!

• Only $500 for an initial investment, $200 if invested within an IRA

• No subsequent investment minimums

• Affordable on any budget!

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Expense Ratio

• Ratio is .76%• Experts recommend a ratio less than 1.4%

Clements,J. (2000). Cutting Through Mutual Fund Clutter. The Wall Street

Journal. May 2000. D1 • NASD Calculations $10,000 initial

investment assuming 5% return, 20 years equals expenses of $2,352

• Use NASD to compare to other fund’s expenses

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Historical Returns

3 year 5 year 10 year

Homestead 14.46% 10.85% 9.94%

S&P 500 Index

10.44% 6.19% 8.42%

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Rating Systems

• Morningstar’s Stars: ****

• Business Week: B

• Consumer Reports: 82/100

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Selling Points

• Not the end all-only fund you’ll ever need but it’s a great place to get started:– Good for long term investors– Low investment minimum, can set up

subsequent investment minimums to fit your individual budget

– Management Tenure is 33 years– Solid returns which outperform its index (Goal

of actively managed funds)

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Contact Information

• Homesteadfunds.com

• Ticker: HOVLX

• 1-800-258-3030

• What questions do you have?

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Focus on the Future

• “Past performance is no guarantee of future returns.”

• It’s very difficult to beat “the market” (represented by an index such as S&P 500) in any one year and even harder to do this consistently.

• The only thing you know about the future is the fund’s expense ratio.

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How to Choose? • If you can afford $3,000 investment

– Vanguard Total Stock Market Index• Own a representative sample of all publicly traded U.S.

stocks (with low expenses)

– Vanguard Target Retirement Fund• Widely diversified investment classes (stocks & bonds)• Less volatile than 100% stocks• Rebalances automatically as you approach retirement

• To start with low initial investment $50 AIP– T. Rowe Price Target Date Retirement Fund

• Have $200? Don’t want to commit to AIP?– Homestead Value

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How to open an IRA

• Simple process– Online– Call and get forms in mail

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How Does Your IRA Compare?

• Want to transfer to one of our recommendations?

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It’s not magic, just do your homework