Chapter 13

Mutual Funds

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

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So What Do We Do?
 Determine risk
preference

 Decide on asset
allocation

 Create a portfolio

 Hold for the long term

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Create portfolio through mutual funds

Pool money from investors with similar goals

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Mutual Fund
 Hire a management
company to run
the fund

 Invests in
numerous
securities

 Sends statements

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What Really Happens

 We contact mutual
fund to invest

 We buy shares in
the fund:

$2,000/$100 = 20 shares

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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

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 Why Invest in Mutual Funds?
 Instant diversification  Liquidity

 Level the playing field  Minimal transaction

between professional costs
and individual
investors
 Convenience
 Share administrative
expenses

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Disadvantages of Mutual Fund Investing

 Lower-than-market performance

 Costs

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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

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Types of Funds
 Open-end

 Closed-end

 Unit investment trust (UIT)

 Exchange traded fund

(ETF)

 Real-estate investment
trust (REIT)
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Objectives of Mutual Funds

 Money market mutual funds

 Stock mutual funds

 Bond funds

 Asset allocation funds

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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

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 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%)

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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

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 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.

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

 Determine your time horizon and risk

tolerance

 Determine your asset allocation

preferences

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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
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 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

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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
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 Making the Purchase

 Buying through a
broker

 Buying directly from

the mutual fund

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Questions?

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