12 -- Part 3: Mutual Funds and Exchange-Traded Funds
The most popular index funds are those that track the S&P 500.
Drug companies, hospital management firms, medical sup pliers, and biotech concerns are some of the stocks that a health care sector fund would focus on.
Technology, financial services, real estate, natural resources, telecommunications, and health care are some of the more popular sector funds.
Capital gains are the main investment objective of a sector fund.
A sector fund should be considered speculative because it is not well diversified and is similar to a growth fund.
Investing is more than just financial ratios and calculating investment returns for some.
The security selection process includes active, explicit consideration of moral, ethical, and environmental issues.
Social concerns should play a bigger role in investment decisions than financial matters.
A number of funds cater to such investors.
Their investment decisions are based on morality and profitability.
Only certain companies are considered for inclusion in the portfolios of socially responsible funds.
If a company doesn't meet the fund's moral, ethical, or environmental tests, fund managers won't buy the stock.
These funds do not invest in companies that derive revenues from tobacco, alcohol, gambling, weapons, or fossil fuels.
The funds tend to favor firms that produce "responsible" products or services, that have strong employee relations and positive environmental records, and that are socially responsive to the communities in which they operate.
There are several important factors, but they don't focus on individual security selection.
An old mutual fund industry has created a product to do the job for investors who have a hard time making asset allocation decisions.
The decision is based on age.
Most mutual funds only invest in one type of portfolio, so the investor's age should be taken into account.
Many of them include a foreign portfolio that is 75% invested in securities, and some even include inflation-resistant investments, such as gold, stock, but as the investor ages, the real estate, and inflation-indexed bonds.
These funds are for people who want to hire fund managers who are less risky than stocks.
A typical asset allocation fund works like this.
50% to U.S. stocks, 30% to bonds, 10% to foreign securities, and 10% to money market securities are recommended by many financial planners.
The manager purchases securities from investors who are at least 120 years old.
The asset allocation mix changes as market conditions change.
If the U.S. stock market starts to weaken, the fund may reduce the domestic stock portion of the portfolio to 35% and increase the foreign securities portion to 25%.
There is no guarantee that the money manager will make the right decisions.
A target date fund is a type of asset allocation fund.
The fund's asset allocation is heavily tilted toward stocks, but as time passes and the fund's target date approaches, the portfolio becomes more conservative with the allocation shifting away from stocks towards bonds.
The funds appeal to investors who want to save money.
A 25-year-old worker might choose a fund with a target date of 2055, while a 45-year-old might choose a fund with a target date of 2035.
By choosing target dates that correspond to their expected retirement dates, both investors can be assured that the fund man agers will gradually lower the risk profile of their investments as retirement approaches.
Most of the funds invest in foreign securities.
A lot of people want to invest in foreign securities but don't know how to do it.
International funds may be just the vehicle for such investors if they have at least a basic understanding of international economics issues and how they can affect fund returns.
The funds tend to confine their activities to specific regions.
International stock funds, international bond funds, and even interna tional money market funds can be found.
Aggressive-growth funds, balanced funds, long term growth funds, and high-grade bond funds are available.
There are funds that only invest in Japan, Germany, and Australia, and others that only invest in emerging markets like Thailand, Mexico, and even former Communist countries like Poland.
International funds accounted for 25% of all assets invested in stock mutual funds.
There are other important reasons for investing in mutual funds, not the least of which are the valuable services they provide.
Automatic investment and reinvestment plans, regular income programs, conversion privi leges, and retirement programs are some of the most sought after mutual fund services.
Money is needed to make money.
Being able to accumulate the capital is what an investor needs to put into the market.
There is a program that mutual funds have come up with.
Fund shareholders can use this service to transfer money from their bank accounts into a mutual fund.
It's similar to a payroll deduction plan.
The fund service allows shareholders to invest on a regular basis without having to think about it.
Almost every fund group has an automatic investment plan for its stock and bond funds.
To enroll, you simply fill out a form authorizing the fund to take a set amount from your bank account at regular intervals.
You will be buying more shares on a regular basis once you enroll.
If it's a load fund, you'll still have to pay normal sales charges on your periodic investments, though many load funds reduce or eliminate the sales charge for investors participating in automatic investment plans.
If you call the fund, you can get out of the program at any time.
It is possible that convenience is the main advantage of automatic investment plans.
Adding funds to your investment program systematically over time is one of the best ways to build up a large amount of capital.
It's important to make regular contributions to your investment portfolio.
It is right up there with compound interest.
Every open-end fund offers an automatic reinvestment plan, which is one of the real draws of mutual funds.
Automatic reinvestment plans deal with the dividends the funds pay to their shareholders, whereas automatic investment plans deal with money you put into a fund.
Commissions are not charged for purchases made with reinvested funds.
Even though you can reinvested dividends and capital gains distributions, the IRS still considers them to be cash receipts and taxes them as investment income in the year in which you received them.
You can earn fully compounded rates of return with automatic reinvestment plans.
You can increase earnings by plowing back profits.
The long run effects of these plans can be substantial.
The upper and lower lines show how much money is late if the investor keeps reinvesting dividends.
The difference in these two approaches becomes larger over time.
If the investor had reinvested dividends, the portfolio would have been worth $149,223 by July 2015, but if they hadn't, the value would have been just $80,000.
Automatic investment plans are great for long-term investors.
Again, mutual funds have a service to meet this need.
An investor gets a preset amount of money every month or quarter.
Most funds require a minimum investment of $5,000 or more to participate, and the size of the minimum payment or mally must be $50 or more per period, with no limit on the maximum.
First, the funds will pay out the monthly or quarterly income from dividends and realized capital gains.
The shareholder can authorize the fund to tap the principal or original paid-in capital if the source proves inadequate.
Sometimes investors need to switch out of one fund and into another.
The investment climate may have changed.
One's investment position can be impacted by reinvested dividends.
The results of investing $10,000 in the S&P 500 in January 1988 are shown in the graph.
Conversion leges allow shareholders to move money from one fund to another via phone or the internet.
The only restriction is that the switches are limited to the same family of funds.
You can switch from a Dreyfus growth fund to a Dreyfus money fund or any other fund managed by Dreyfus.
Conversion privileges allow you to meet ever-changing long-term goals and allow you to manage your mutual fund holdings more aggressively as the investment environment changes.
There is a major problem.
The exchange of shares from one fund to another is considered a sale transaction for tax purposes.
Self-employed individuals can divert a portion of their pretax income into self-directed retirement plans.
Individual retirement arrange ments are allowed for U.S. workers.
Qualified investors can now choose between deductible and non deductible IRAs.
Special nondeductible IRAs can be set up by people who make too much to qualify for one of these programs.
M13_SMAR3988_13_GE_C12.indd 521 13 May 2016 10:56 AM The funds set up the plans so that the shareholder can take full advantage of the tax savings.
Some investor services are provided by mutual funds.
You are confronted with a situation.
You want to pick a security that will give you an attractive rate of return and meet your idea of acceptable risk.
The problem is that you have to pick from a lot of securities.
That's what you're facing when trying to find a suitable mutual fund.
If you approach the problem in a systematic way, it may not be doable.
It would be helpful to examine the different uses of mutual funds.
The selection process and several measures of return can be looked at with this background.
Matching your investment needs with the investment objectives of the funds is how it is possible to cut down the list of alternatives.
There are many ways in which mutual funds can be used.
Performance funds can serve as a vehicle for capital appreciation, whereas bond funds can provide income.
Regardless of the kind of income a mutual fund provides, investors tend to use these securities as (1) a way to accumulate wealth, (2) a storehouse of value, or (3) a speculative vehicle for achieving high rates of return.
This is the most common reason for using mutual funds.
The investor uses mutual funds to build up their invest ment capital.
Preservation of capital and capital stability are important, but a modest amount of risk may be acceptable.
You provide the capital by systematically investing and reining in the fund and the fund provides the return by doing its best to invest your resources wisely.
mutual funds are used by investors as a storehouse of value.
The idea is to find a place where investment capital can be fairly secure and relatively free from degradation yet still generate a relatively attractive rate of return.
Money funds and short- and intermediate-term bond funds are logical choices.
Capital preservation and income are important to some investors.
Money funds can be used to "sit it out" until a more attractive opportunity comes along.
Speculation is still not used by most mutual fund investors.
Most mutual funds are long-term in nature and not meant to be used as aggressive trading vehicles.
A growing number of funds cater to speculators.
Some investors think that mutual funds are attractive for speculation and short-term trading.
As the investment climate changes, aggressively trade in and out of funds is one way to do this.
Load charges can be avoided by dealing in families of funds with low-cost conversion privileges or by only dealing in no-load funds.
Other investors might choose mutual funds as a long-term investment but want high rates of return by investing in funds that follow very aggressive trading strategies.
These are usually small funds such as leverage funds, option funds, emerging-market funds, small-cap aggressive-growth funds, and sector funds.
Every investor has a question when it comes to mutual funds.
The answer is simple, with mutual points in the Investment Company Institute, for beginning to be quite low.
You are able to achieve far more diversification with funds than you could ever do on your own.
You can get the help of professional money managers at index funds with fees that are 10 to a very reasonable cost.
The answers are 20 times higher for more seasoned investors.
Diversification and professional money management are charged by a typical fund.
The services they provide and the competitive returns that investors in these funds tend to earn are factors.
Many sea investors who buy shares in index soned investors simply decided they can get better returns by carefully funds that charge lower fees.
The selection process involves putting into action all you know about mutual funds in order to gain as much return as possible.
It starts with an assessment of your needs.
You want to pick from the one or two funds that will best meet your total investment needs.
Your investment objectives are the place to start.
An attractive rate of return is desirable, but there is also a lot of risk exposure.
It is likely that certain types of mutual funds are more appealing to you than others if you look at your own risk temperament.
Aggressive-growth or sector funds are not attractive to people who want to avoid high risk.
The intended use of the mutual fund is an important factor.
This information gives you a better idea of what you want to do with your money.
The fund provides services.
If you're interested in certain ser vices, be sure to look for them in the funds you choose.
Each fund has a different investment objective, a different manner of operation, and a different range of services.
You can use these elements to assess investment alternatives.
The fund's profile is an obvious place to start.
There are a number of reporting services that provide background information.
Performance statistics can be found on the Internet.
Historical information on a fund's performance, security holdings, risk profile, load charges, and purchase information can be found in Finance.
Fund selection becomes a process of elimination at this point.
A large number of funds can be eliminated because they don't meet your needs.
Some funds are too risky to be used as storehouses of value.
Rather than trying to evaluate thousands of different funds, you can narrow down the list to two or three funds that match your investment needs.
You can make the list a bit more manageable by introducing other constraints.
Because of cost considerations, you may want to consider only no-load or low-load funds.
Some services are important to your investment goals.
Funds with low dividends and low asset turnover do not expose their share holders to high taxes and therefore have higher tax-efficiency ratings.
Check out the fund's fee structure while you're looking at performance.
There are funds that charge high management fees.
How well a particular fund fits into your port folio is an important consideration.
When you're thinking about adding a fund to your portfolio, be sure to take into account the asset allocation strategy you're trying to follow.
Evaluate any particular fund in the context of your overall portfolio.
It may seem intuitive that funds with good past performance should make better investments, but remember superior past performance is not a guarantee of future success.
We would say that past performance has almost no correlation with future performance.
We recommend that you place more weight on the fund's objectives and costs when making your investment decisions.
Load funds and no-load funds have a long-standing debate in the mutual fund industry.
The idea that load funds provide added value is not supported by empirical results.
Load-fund returns do not seem to be any better than the returns from no-load funds.
In many cases, the funds with high loads and 12(b)-1 charges produce returns that are less than what you can get from no-load funds.
With longer holding periods, the differential returns tend to widen.
Big load charges and 12(b)-1 fees reduce your investable capital and therefore the amount of money you have working for you.
The only way a load fund can overcome this handicap is to produce returns, which is hard to do year in and year out.
A few load funds have produced attractive returns over time, but they are not the norm.
It's in your best interest to pay close attention to load charges.
If you want to maximize returns, you should stick to no-load funds or low-loads.
You're better off trying to minimize load charges when the higher costs are justified.
There are thousands of no-load and low-load funds to choose from.
Most of the top-performing funds are found in the universe of no-loads or low-loads.
The assets of closed-end funds make up just over 1% of the $18 trillion invested in open-end mutual funds.
CEFs come in a variety of styles and types, including funds that specialize in municipal bonds, taxable bonds, various types of equity securities, and international securities, as well as regional and single-country funds.
Bond funds have accounted for more assets in closed-end funds than the open-end market has.
There was $170 billion worth of bond CEFs assets.
Equity CEFs had $119 billion in assets.
Because closed end funds trade like stocks, you have to deal with a broker to buy or sell shares.
Open-end funds are bought from and sold to the fund operators.
There is a difference between open and closed-end funds.
It is possible to buy and sell large amounts of open-end mutual fund at its net asset value without affecting the price.
There is a large buy or sell order for a CEF.
The way these funds are priced in the marketplace is probably the most important difference.
Financial experts sometimes refer to the closed end fund puzzle as the reason why CEFs trade at a discount.
The closed-end fund share prices are lower than the NAVs.
If you buy shares in a CEF, you are buying the underlying stocks in the fund at a discount.
There are a number of possible reasons that CEFs trade at a discount.
If the fund's future performance is poor, investors will pay less for shares in the fund up front.
If the fund ever sells its shares, they will sell for less than their current market prices.
They are unwilling to pay the full NAV when they purchase fund shares because they have built-in capital gains that will eventually be taxed.
When investor sentiment is positive, fund shares trade at a premium, but when investor sentiment is Pessimistic, fund shares trade at a discount.