Notes

unit 7 lesson 3
12b-1 Fees – A provision of the Investment Company Act of 1940 that allows a mutual fund to collect a fee for the promotion, sale or other activity connected with the distribution of its shares. The fee must be reasonable (typically 1/2 to 1% of net assets managed), up to a maximum of 8.5% of the offering price per share.
•Broker – A statement of the interest income (unearned income) your banking institution paid on your savings account or CD that year.
•Commission – The fee paid to a broker to buy or sell securities; vary greatly from broker to broker.
•Diversification – A risk management technique that mixes a wide variety of investments within a portfolio, thus minimizing the impact of any one security on overall portfolio performance.
•NAV – Net Asset Value - The value of a mutual fund share, calculated once a day, based on the closing market price for each security in the fund's portfolio.
•No-Load Fund – Reduces your taxable income. There are two types of deductions, standard and itemized.
•(Related terms: front-end load) – A mutual fund commission or sales fee that is charged at the time shares are purchased.
•(Related terms: back-end load) – A commission or sales fee that is charged upon the redemption of mutual fund shares, declines over time to zero as stated in the prospectus.
•Prospectus – Financial report for a mutual fund; provides information on the fund's investment objectives, fees, holdings, annual returns, risk, and other financial information.
•Yield – The rate of return on an investment, usually expressed as an annual percentage rate. A yield is not a total return measure because it does not include capital gains or losses.

Advantages
•Diversification - buying a mutual fund provides you with holdings in many different companies.
•Liquidity - mutual funds can be converted to cash upon your request.
•Professional management - an advantage if the fund manager is truly skilled, but can just add to the expense of the fund without producing higher returns.

Disadvantages
•Fees, Fees, Fees - if you are not careful, mutual funds can be so expensive to own that they become a very mediocre investment. Fortunately, you can determine how expensive a fund is fairly easily...before you buy.
•No control - you do not get to choose where your money is invested, or how often holdings are bought and sold.
•Diluted Earnings - the downside of diversification; owning few shares of many stocks can really dilute your earnings because you don't own enough shares to really profit from a single stock's stellar performance.
•Professional management - since most actively managed funds do not perform as well as the overall stock market, it is questionable if the extra expense is necessary.

TYPES OF FUNDS

-Bond Funds
Pooled amounts of money invested in bonds, which represent the debt of companies or governments. If you own a bond, you are basically lending money to the issuer.

-Balanced Funds
Funds that invest in both stocks and bonds. A balanced fund might contain 50-65% stocks and hold the rest in bonds. How the fund is balanced determines how risky it is. A higher percentage invested in stocks will result in a higher risk, and potentially higher returns or losses, for the fund.

-Stock Funds
Funds that invest in stocks, which as you know come in a variety of sizes, and from different sectors. Some funds will invest primarily in companies of one size, so they are categorized as large-cap, mid-cap, or small-cap funds (representing the market capitalization of the companies they are invested in). Basically, these types of funds reflect the types of stocks they invest in.

-International Funds
Funds that invest in foreign companies, representing many different nations. These funds are often more volatile than funds that invest in U.S. stocks.

-Global Funds
Funds that invest in both U.S. and international-based companies. These funds are also more volatile than funds that invest solely in U.S. stocks.

-Sector Funds
Funds that invest in one particular sector of the economy, like energy, health care, technology, financial, etc. These funds do not offer the same level of diversification as other funds, because their holdings are all in one sector of the economy. This also makes these funds more volatile.

-Index Fund
Funds that attempt to match the returns of a specific stock benchmark or index. They invest in the stocks that are represented in a given index, such as the S&P 500, to try to match the returns of that section of the market. These funds don't have a fund manager because the holdings are determined by the index the fund is trying to equal. The advantages of this type of fund include low fees and solid returns.

FEES
Types

-Expense ratio
Percentage that represents the total fees you will be charged for owning the fund. A typical expense ratio for funds with a professional manager is around 1.5%. Index funds typically average .25% for the entire expense ratio! The expense ratio is important because it reduces your earnings. If the fund's return was 15% for the year, the 1.5% expense ratio of the professionally managed fund would reduce your earnings to 13.5%.The expense ratio is made up of the following fees:
1.Management fee: the money to pay the professional fund manager. It has typically been between .05% and 1% of the fund's assets.
2.Administrative costs: pays for record keeping, customer service, and mailings. These should be low, typically about .2% of the fund's assets.
3.12b-1 distribution fee: pays for advertising, marketing, and distribution services. They are charging you to advertise the fund, and it can range from .25% to 1% of the fund's assets.

-Loads
With mutual funds, load means fee for selling or buying the fund, if a broker's services are used in selling the fund. "No-load" funds are simply those that are sold directly to the investor and charge no fee.
1.Front-End Load: a percentage of your investment paid to the broker or company advisor when purchasing the fund. It can be as much as 5% of your investment, and should be avoided.
2.Deferred Load (Back-End Load): a percentage of your investment charged when you sell shares of the fund. This extra fee should also be avoided.

-Turnover
How often a fund buys and sells the stocks it holds. Each time it sells stock, a fund pays a fee. The less trading a fund does, the lower its turnover will be, which means less costs. Actively managed funds average 80% turnover while index funds are around 5%.


Selecting a fund
more funds isn't always better
•Returns - are they consistent?
•Expense ratio - the lower, the better
•Sales charges - pay no sales charges
•Turnover - the lower the better
•Cash reserves of the fund - should be very low