Understand the Working of Mutual Funds

Half of all the households in America invest in mutual funds. For most people mutual fund investment is better than keeping money in the bank. Mutual funds are companies that invest money in stocks, bonds and other securities. When you buy mutual funds your money is a portion of the holdings of the fund. Make money in Mutual funds in a sure and safer way rather than following the swings on Wall Street.

Not all mutual funds have delivered and putting your money in a mutual fund does not necessarily give you good returns. How can you make money from mutual funds?

o Income from mutual funds is earned from dividends on stocks and interest on bonds.

o If securities have increased in price and the fund decides to sell the securities, then the fund has made a capital gain which it passes on to its investors.

o The mutual fund holds shares and if these shares have increased in price. You can sell your mutual fund shares for a profit.

o You could reinvest your earning and get more shares as well.

o Mutual funds is a long term investment option

Is Mutual Fund investment a good option?

Get to know mutual fund basics and invest in the best mutual funds and your investment is a wise one. Why are mutual funds safer than stock market? Since the money of the fund is diversified the risk of the company is less. Even though gains in some investments are minimized due to losses in others they still stand to gain in transaction costs as it is for large amounts of securities. The good about mutual funds is that you do not have to follow the prices of stock and get worried about loss. Liquidity is also there since you can convert your shares into cash at any time. Many banks have their own mutual funds and a small investment of $100 on a monthly basis can reap good rewards. On going yearly fees and transaction fees are the costs that eat into your mutual funds profits. Fees for the sales persons and brokers also eat into your funds. These are called loads. There types of loads are front end loads and back end loads. So it is best to choose a fund with no loads.

Types of mutual funds

Each fund describes its investment objective. Since it is predetermined you can choose whether to invest in it or not. Each All mutual funds are variations of three basic classes.

o Equity Funds invest in stocks

o Fixed-income funds invest in bonds

o Money Market funds are diversified

Equity funds require a long term capital growth with some income. The best returns can be understood by the companies invested in. Large cap companies are the safest equity investments.

Bond/Income funds give you higher returns but are risky if they are not invested in government securities. Also another factor is the high inflation risk which brings down the profit on your investment.

Money market funds are investments mostly in treasury bills. This is a safe investment option. Your returns may be twice that offered by banks, though not much your principal is safe.
Other varieties of mutual funds are

o Growth funds are the investment in the equity of fast growing companies.

o Specialty funds are the investment in equity of companies that are of the same sector or region.

o A balanced fund is a combination of fixed income funds and equity funds. Asset allocation fund has objectives similar to that of a balanced fund.

o Socially responsible funds do not invest in industries such as tobacco, alcoholic beverages, weapons or nuclear power. Maintaining a healthy conscience is a criterion of this fund.

o Index funds replicated the performance of the market index such as Dow Jones or ‘Standard and Poor’s 500’

http://www.fundsavvy.com is a site that gives you info on mutual fund basics , mutual fund investment etc. There are many more articles that could help you make a wise investment choice in the fund market.

The 4 Best Advantages of Investing In Mutual Funds

Mutual funds have grown in popularity over the last few years to the point where it’s harder to find an investor who is not using mutual funds than one who is. The popularity of mutual funds is no surprise when you consider that they are one of the easiest investments to use and require very little knowledge of the financial markets. There are 4 main advantages that mutual funds offer every investor, as you will learn in this article.

The first advantage of mutual fund investing it that mutual funds offer professional management of your investment dollars. Mutual funds are run by fund managers, who are essentially watching over your investment daily. There is almost no other place where you get that kind of investment management without paying huge management fees.

The second advantage of mutual fund investing is that mutual funds are extremely liquid. Any investor can sell his shares in a mutual fund any day that the stock market is open. Compare that to investing in real estate, CDs or even stocks that have low trading volume which can takes weeks to months to liquidate your stake. The liquidity of mutual funds gives any investor the ability to get out of the investment quickly if needed.

The third advantage of mutual funds is the diversification that they offer. Mutual funds invest in tens or even hundreds of different stocks, bonds or money markets. Trying to duplicate this type of diversification in your own portfolio would result in very high trading fees, not to mention huge headaches from tying to monitor hundreds of stock positions. This leads us into the fourth advantage of mutual funds, lower fees.

Mutual funds have very low fees due to their ability to take advantage of economies of scale. Since mutual funds are pooling the investment dollars of so many investors they can buy stocks in larger quantities which leads to lower fees for mutual funds investors. Numerous mutual funds have fees that are under 2 or 3%.

Mutual funds are growing at a feverish pace as more and more investors put their money in them. But considering the great advantages that mutual funds offer the average investor all the way up to guy with the multi-million dollar portfolio, it’s really no surprise.

Investing in Mutual Funds 101

Have you ever heard the phrase “it takes money to make money”? Chances are you have, but do you know how to do it? Well, investing in mutual funds presents an excellent opportunity to invest the money that you have to create MORE! Mutual funds are perfect for people who would like to invest there money is a safe, simple way, while still maintaining a diversified portfolio.

One of the golden rules of investing states: when you diversify your investments you reduce your risks without losing your returns. This is exactly what makes mutual funds do. So, how do you go about choosing the mutual fund that’s right for you? Read on and learn more about these investment gems and you’ll be putting your money to work in no time!

A mutual fund is a collection of money, pooled together by all of its investors, used to purchase specific types of securities. These investments within the mutual fund are decided by investment professionals who run the mutual fund. The professional picks from a wide variety of stocks, bonds, money market instruments, or other financial instruments. The investments selected will depend on the fund’s investment objectives. Because of this, it is very important to choose a fund with objectives that are compatible with yours.

There are many benefits to consider when dealing with mutual funds. One major benefit is that mutual funds cost less. Unlike many single stocks, you do not have to have a lot of capital to purchase mutual funds and you can invest small amounts of money at any time with no additional trading costs. This makes mutual funds an excellent alternative to the low interest savings accounts found at local banks. Another benefit to consider is the face that mutual funs are very liquid. If you ever need to access your money invested in a mutual fund, it is very easy to do so.

If you decide to invest in a mutual fund, you will be faced with a slight challenge; “which mutual fund do I choose?” There are over 10,000 mutual funds available at any time, so choosing which one to invest in can be an overwhelming decision. A great way to start is by researching different funds’ past performance records and future goals. Along with this you should also consider what fees the mutual fund charges, it is usually a good idea to go with a fund that offers a low expense ratio and to avoid funds with additional sales charges.

Another key factor in choosing a mutual fund is RISK. If a fund shows a rocky past of instability, you should think twice before investing your hard earned cash into it. Also, always check with the US Securities and Exchange Commission (SEC) to make sure the company is legitimate and holds a good upstanding reputation.

You will also have to consider which type of mutual fund to you would like to invest in. There are many different types of funds, such as, stock funds, index funds, municipal bond funds, corporate bond funds, money market funds, U.S. Government bond funds, and mortgage-backed securities funds.

Mutual Fund Investing Basics

Have you been considering investing money in mutual funds but you don’t know where to start? With several thousand mutual funds to choose from it can be a daunting task. Do not let this discourage you from investing in mutual funds. Over time, the stock market and mutual funds have proven to be a good long term investment. Sure they can go down, but the longer your time frame, the more likely it is you can succeed with mutual funds.

First, you should know exactly what a mutual fund is. A mutual fund is a professionally managed portfolio of investments such as stocks and bonds. When you buy a mutual fund share you own a little piece of every investment in the mutual fund’s portfolio. If the value of these investments go up, the value of your mutual fund’s share price will go up. The opposite holds true as well. If the investments go down, the mutual fund’s price per share or NAV (Net Asset Value) will go down. The type of investments each mutual fund can invest in is specifically stated in the fund’s prospectus. For example, an equity fund will usually invest in stocks while a bond fund will invest in bonds. Of course, there are mixed funds that can invest in both stocks and bonds. The type of mutual fund that is best for you depends on factors such as your age, risk tolerance, and investment goals.

Next, you should learn the main two advantages of investing in mutual funds. The first one is diversification. If you are just getting started in investing, a mutual fund allows you to spread your risk over many companies. By doing this you are effectively decreasing the likelihood of making poor investment choices. For example, if you were to only pick one or two stocks and either of them performed poorly your portfolio would almost certainly decrease. However, in a mutual fund, you own a lot of different companies so it doesn’t matter that much if a few of the companies perform poorly. The other big advantage of a mutual fund is professional management. If you are unsure of what investments to buy yourself or simply don’t have the time to do the research it is very helpful to have a professional do that for you. Of course, this professional service is not free. Each year a management fee is charged to the mutual fund. The percentage of the fee charged can vary from fund to fund so make sure the fee charged is “in line” with other mutual funds.

Now that you know what a mutual fund is and the top reasons to buy a mutual fund, you need to decide what type of mutual fund to buy. Do you want to achieve growth, income, or both? Do you want to invest in U.S. markets, foreign markets, or both? Do you want to buy a no-load fund, class A shares, or class B shares? All of these questions should be considered before making your final decision.

Navigating the World of Mutual Funds

Since the 1920s, mutual funds have helped Americans achieve their financial goals. Today they are one of the most popular investments. According to the Mutual Fund Education Alliance, more than 80 million investors in the United States own mutual funds.

But if you’re like most investors, you may have questions about different fund types, class shares, expenses and how to select the funds most suitable to your investment needs. You’ll find answers to these questions in this five-part series of articles about the world of mutual funds.

What is a mutual fund?

Mutual funds are often referred to as open-end funds. This means there is no limit to the number of shares investors can buy and sell. You might also hear about closed-end funds, which are investment companies that sell a fixed number of shares traded only on the stock market.

The money you invest in a mutual fund is pooled along with that of other shareholders with similar financial goals. Most mutual funds are part of a larger investment company or family of funds. Each fund is managed by a team of professional money managers who monitor the fund’s performance and, based on thorough research, choose investments they believe will help the fund reach the investment objectives stated in the prospectus (for example, current income or capital growth).

Because a mutual fund is essentially a collection of different investments, investors use them to reduce investment risk without having to purchase individual stocks and/or bonds. Diversification, while recommended, does not guarantee a profit or ensure against a market loss.

Another advantage of investing in mutual funds is liquidity. Generally, you can redeem or sell your shares any day the stock market is open. However, you should keep in mind that investment values will fluctuate and there is no assurance that the objective of any fund will be achieved. Mutual fund shares are redeemable at the current net asset value, which could be more or less than their original cost. Fund annual operating expenses apply as well as plan administration charges. These are described in the prospectus.

Stock mutual funds

If you’re considering investing in a mutual fund, you’ll need to know about the types of funds that are available. You can select a stock or equity fund, bond fund, balanced fund (a combination of stock and bond funds), lifestyle fund or money market fund. In Part Two of this series, we’ll take a look at stock funds.

Generally, stock or equity mutual funds are best suited for investors who:

o Seek capital growth over extended periods of time
o Are willing to tolerate share-price volatility
o Have an investment horizon of five or more years

Stock funds can have different investment objectives and target companies in various industry sectors and market capitalization (the gauge of a company’s size or value). Funds invest in companies within one of the three market capitalization categories: large-cap funds (more than $11.7 billion), mid-cap funds ($2.9 billion to $11.7 billion) and small-cap funds (up to $2.9 billion).

The following are the different types of stock funds, ranked in order of the highest to lowest investment risk:

Aggressive growth funds-Seek rapid growth of capital, often through investment in smaller companies and with investment techniques involving high-risk, short-selling, leveraging and frequent trading.

Growth funds-Seek capital appreciation by investing in equity securities of companies with earnings that are expected to grow at an above-average rate. Current income, if considered at all, is a secondary objective.

Growth and income funds-Seek capital appreciation and current income equally by investing in equity securities that have above-average yields and some potential for appreciation.

Income funds-Seek income rather than capital appreciation by investing primarily in equity securities of companies offering good dividends.

International stock funds-Invest at least two-thirds of their portfolios in equity securities of companies located outside the U.S. (global stocks). Domestic (U.S.) stocks may or may not be held.

Specialty funds-Seek capital appreciation by investing at least 65% of assets in equities of a single industry or sector, such as financial services, healthcare, natural resources, precious metals, real estate or utilities.

Lifestyle Funds-Invest in other funds and are optimized to reflect levels of risk and return suitable to specific times of an investor’s life.

Bond funds

As the name suggests, bond funds are mutual funds investing in various types of bonds. Bond funds may be appropriate for investors who:

o Value relatively steady income over growth
o Seek yields that are potentially higher than money market rates
o Want to diversify investments
o Can accept modest fluctuations in the share price

Bond funds aren’t the same as bonds. There’s no fixed yield nor contractual obligation to repay investors their principal at a future date, as is the case with bonds. Bond fund managers continually trade their positions, so the risk-return characteristics of a bond fund investment is always changing, just as with other mutual fund investments.

The main types of bond funds include:

Corporate bond funds-Seek a high level of income by investing two-thirds or more of their portfolios in corporate bonds.

Global bond funds-Invest in worldwide debt securities. Up to 25% of their portfolio’s securities (not including cash) may be invested in companies located in the United States.

Government bond funds-Invest at least two-thirds of their portfolios in U.S. government securities and have no stated average maturity. Bonds issued by Uncle Sam are backed by the full faith and credit of the U.S. government.

High-yield bond funds-Seek a high level of current income by investing at least two-thirds of their portfolios in lower-rated corporate bonds (Baa or lower by Moody’s and BBB or lower by Standard and Poor’s rating services).

Mortgage-backed funds-Invest at least two-thirds of their portfolios in pooled mortgage-backed securities.

National municipal bond funds-Invest predominantly in municipal bonds. The funds’ bonds are usually exempt from federal income tax but may be taxed under state and local laws.

Other world bond funds-Invest at least two-thirds of their portfolios in a combination of foreign government and corporate debt. Some funds in this category invest primarily in debt securities of emerging markets.

State municipal bond funds-Invest primarily in municipal bonds of a single state. The funds’ bonds are exempt from federal and state income taxes for residents of that state.

Strategic income funds-Invest in a combination of domestic fixed-income securities to provide high current income.

Other mutual fund investments

In addition to the stock and bond funds described in previous articles, mutual fund investing offers other choices that might be appropriate to your circumstances and goals. These choices include:

Balanced funds

These funds, also known as hybrid funds, are a combination of stock and bond funds. Balanced funds seek high total return by investing in a mix of equities, fixed-income securities and money market instruments. Unlike flexible portfolio funds, these funds are required to strictly maintain a precise weighting in asset classes.

Money market funds

Money market funds typically invest in short-term government and company loans, which, while lower-yielding, are generally less risky than many other types of funds. Money market funds can be appropriate for investors who:

o Need access to their money in the near future
o Are looking for a current short-term rate of interest
o Are very conservative in their investment approach

An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Therefore, while the fund seeks to preserve the value of your investment at $1 per share, it is possible to lose money while investing in the fund.

Classification of class shares

When you invest in a mutual fund, you purchase a share of that fund. There are different share classes in which you can invest, the most common of which are class A, B and C shares. Share classes vary mainly in the type of sales charge and expenses you incur. The best share class for you depends on a number of factors, including the amount you plan to invest and how long you plan to hold the shares.

Share types

o Class A shares have a front-end sales charge you pay at the time of purchase and is deducted from your investment amount.

o Class B shares typically do not have an up-front sales charge. Instead, a class B share has a contingent deferred sales charge (CDSC) that declines each year until it eventually expires. Once their CDSC expires, Class B shares convert to Class A shares.

o Class C shares do not have an initial sales charge. Rather, they also have a contingent deferred sales charge-typically 1% if shares are sold within the first year. They do not convert to Class A shares and have an ongoing, higher management fee.

Operating expenses

All mutual funds have operating expenses that may include management fees, distribution fees or 12b-1 fees and shareholder mailings, among other expenses. You do not pay for these directly. Instead, they are deducted from the fund’s net assets-or the overall return of the fund. For more information on a fund’s fees and expenses, refer to the fund prospectus.

A fund’s total expense ratio is the combination of the different operating expenses, such as advisory fees, distribution fees and ongoing fees. The fund’s expense ratio is a means to compare its cost to that of other funds and to learn about the fund’s fees and expenses.

Shareholder fees include any commissions paid to brokers when shares are bought or sold. These commissions are often described as “front-end loads” (sales charges when you buy) or “back-end loads” (sales charges when you sell). No-load funds, as the name implies, do not have front-end or back-end sales charges, but generally do have operating expenses and shareholder fees.

Taxes

Each year, mutual funds outside of an employer tax-qualified plan must distribute substantially all of their income and capital gains to shareholders. As a result, shareholders of a mutual fund generally must pay income taxes on dividends and capital gains, if any. Each fund provides an IRS Form 1099 to shareholders annually to summarize the fund’s dividends and capital distributions. Then, when a shareholder sells shares of a fund, the shareholder will realize either a taxable gain or a loss.

Determine your financial objectives

Choosing the type of investment that is right for you depends on your financial goals. Are you saving for college or your retirement? Do you need stable income or can you afford a longer-term investment with greater historical risk, but potentially higher returns? Before investing in a fund, carefully review the fund’s investment style, performance history and expense ratio, and consider your time horizon and level of risk tolerance.

A Small List of Mutual Funds

In the investment market, you can find a list of mutual funds to choose from. There are various investors in the market with varied needs, objectives and risk profiles. So, one fund cannot satisfy all the preferences of the investors.

Classification of Mutual Funds

Normally, an MF is classified into two broad categories:

-On the basis of execution and operation
-On the basis of yield and investment pattern

The list of mutual funds based on execution and operation are:

-Open-ended Fund – In this scheme, the corpus and time of the fund is not prefixed. You can purchase and sell any number of units at any time. The main features of these funds are flexibility, instant liquidity, not traded publicly through any exchanges, ability to repurchase and resell and so on. The main purpose is income generation and their prices are associated to Net Asset Value (NAV) of the units.
-Close-ended Fund – In this scheme, the corpus and duration of the fund is pre-determined. The fund expires when the subscription reaches the fixed target. The main purpose is capital appreciation. Since these are traded on stock exchanges, any market trend (both favorable and unfavorable) affects the performance of the fund.

The list of mutual funds based on yield and investment pattern are:

-Income Fund – The main objective of this scheme is to generate and distribute income to the investors periodically. The income generated is usually higher than that from bank deposits. The investment pattern is usually oriented towards high and fixed income generating securities. This is the best option for retired people.
-Growth Fund – These funds concentrate in generating long term capital appreciation and do not provide any regular income. They are also referred to as ‘Nest Eggs’ funds. The investment strategy is oriented towards equities which have high risk tolerance and high growth potential. This is best suitable if you are salaried or if you are a business person.
-Balanced Fund – These funds are a combination of income and growth mutual funds. They are also known as ‘income-cum-growth’ funds. They mainly concentrate in allocating regular income along with capital gains. The investment pattern is generally balanced between securities providing high growth and fixed income.
-Specialized Fund – These funds are oriented towards the special needs of specific categories of people. This fund allows foreign investors to invest in domestic securities of other countries. They are usually confined to a particular sector or industry. These funds are highly risky and serve as a good option for high risk takers.
-Money Market Mutual Fund (MMMF) – These are similar to open-ended mutual funds and have all the features of an open-ended fund. But, the investment strategy varies as these are invested in money market instruments like treasury bills, commercial paper and the like.
-Taxation Fund – This fund is essentially a growth fund. The only difference is that it offers tax rebates to the investors. This is the most suited choice if you are a salaried person as you can enjoy tax discounts.

Few Other Classifications of Mutual Funds

Apart from the above-mentioned classification, there is another list of mutual funds. They are as follows:

-Leveraged Fund – Also referred as ‘borrowed funds’. They are mainly used to raise the value size of a fund portfolio.
-Dual Fund – These are a special form of close-ended fund. They give two different kinds of investors an opportunity to make a single investment.
-Index Fund – In this fund, the portfolios are designed in such a way that they move in accordance with the market index.
-Bond Fund – These are income generating funds. The portfolio mainly consists of securities like bonds which have the capacity to generate fixed income.
-Aggressive Growth Fund – These funds are more focused on capital gains. They are highly volatile and are usually invested in securities that are highly speculative.
-Off-Shore Fund – These funds are designed for non-residential investors. These funds are registered in foreign countries. They contain country and currency risk but the returns are high.

So, the decision to invest in mutual funds solely depends on your requirements and risk profile. You could pick a fund that suits your profile from the above list of mutual funds.

Paradigms of Mutual Funds

Introduction

In today’s scenario, one of the upcoming options for investment in the financial market is mutual fund. Mutual funds special features are it: easy availability, risk containment, liquidity, transparency, professional management and decent returns, these above features attract the small investors mainly of average class, the investors play safer game as compare to the up and down of the stock market.

Many private financial organizations like ING VYSA Bank, Standard Chartered Mutual Fund etc are good examples, which allow investors to start with just Rs 500only. Investors seem to have accepted the importance of mutual funds and are know a days ready to invest under various mutual fund schemes.

Suitability of Funds

Mutual Fund suits all class of investors who are interested in raising their personal funds. The investments are based on the risk factor of the investor if the risk is higher the return is also high similarly if the risk is low the return on a particular investment will also be low.
If the risk is slightly-averse, the investor should prefer a balanced fund, which invests in stocks only up to 60-70%. If the investor wants to go for larger risk-averse, stick to growth funds. If the investor wants regular returns than investor must go for income funds, with average risk but the risk is less than equity fund. The Mutual fund managers make decision of the funds depending on the investment objective of the investors. They can go for liquid funds like Cash Funds or short term floating rate funds. They may also go for funds based on when you want your funds back. The investor who wants short term and quick return a short-term bond fund would just be fine as return will be within three to six months. An income fund or an equity fund would fit in if the investor willing to afford the fund to leave it with the fund manager for over a year.

Even within each category, you can pick and choose i.e. in equity funds, for example, you have a variety of options: blue chip funds, mid-cap funds, contrarian funds, opportunity funds, dividend yield funds, sectoral funds that invest specifically in select business segments etc. Equity-linked savings schemes allow you to reap tax gains up to Rs 1 lakh (Rs 100,000) a year.

Many equity funds offer the option of systematic investment plan (SIP) that allows you to invest a certain sum every month or every quarter. This amount is fixed for every installment to be paid. This way, you not only discipline your investments but to a great extent an investor can protect themselves against the vagaries of the market.

Debt funds don’t lack luster either. The investor have a choice medium term debt funds, short-term bond funds, floating rate funds, dynamic bond funds and cash funds. If an investor wants an aggressive debt fund, then they can go for gilt funds. If the preference is a mix of both equity and debt, MIPs or balanced funds would do just fine.

Fair and Transparent dealings

A mutual fund is nothing more than a collective savings pool. Several investors have come together to invest in stocks, bonds or in both. However, mutual funds are strictly regulated. They have to declare their portfolios from time to time. Almost all the funds declare their portfolios every month.

The net asset value (NAVs) of a fund, which points to how much a unit of the fund is worth on a particular day, is declared every working day. You know where your money is going and how it is doing performing in the market.

Easy Access and Availability in Market:

A few years ago, even if you wanted to buy a mutual fund, it was not easy. Few distributors, most of them small, sold mutual funds. The quality of their advice often left a lot to be desired. But today, you could buy mutual funds in over 60 cities or towns, either through their own offices or through banks.
All private sector banks now sell mutual funds across the counters in most branches. Some public sector banks too have begun marketing mutual funds through select branches.

Professionally Managed

When you buy a mutual fund, you hand over the task of investing to a qualified and probably more knowledgeable fund manager who is paid for finding the right opportunities for you. The service standards set by mutual fund companies are better as compare to other sources of raising finance. As other sources of raising funds are more risky than mutual funds as their investor have to do the direct dealings. As for example, most fund distributors will come to your residence or office and explain the product features and also collect your cheque.

If you want to sell your fund, you can do so pretty quickly too, mostly within one or two working days. There is no paperwork to fear. For example, in the case of some income funds, the money will be credited directly into your bank account if the account is held with select banks.

In case of systematic investment plans too, you can do so with auto debits. Every month, on a day you choose, your bank account will be debited with a particular sum and specified mutual fund units available for that sum will be bought. No more hassles of issuing post-dated cheques .

Despite all these facilities, you may have myriad doubts and queries. Mutual funds offer toll-free lines at over 200 locations. For example, call-free telephone line, you can get to know valuations, order for account statements and even redeem your investments without any personal identification number.

Conclusion

Mutual fund investment is better than other raising funds and in the coming years it will prove to be the best source of investors. If past collection figures are a testimony, investors seem to have realized this. Both the public Mutual funds and Private Mutual funds are performing better. The result is moving in upward curve of the financial market. To sum up, mutual funds offer the investor large choices of various schemes with special features and can be chosen on the requirement of the investor.

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References

1. Mc.Donald,Objectives and Performance of Mutual Funds,1991-Pg33-35.

2. R.A.Reddy,Mutual Fund Industry,2002,pg220-226

3. K.Ashwathtappa-Mutual funds growth and development,2006,3rd edition pg 12-19.

4. Journal of Financial and Quantitative Analysis,311-333.

5. “Portfolio Performance”-The ICFAI Journal,2002.

6. Portfolio Organiser-Growth in demand of Mutual Funds,2007.

Mutual Fund Short Comings – 7 Reasons To Invest Elsewhere

The Mutual Fund industry has been a marketing juggernaut since the mid-1980’s. Billions of dollars have been deposited into mutual funds, but that decision by many investors may have cost them more than they realized. There are many reasons why mutual funds are not everything they market themselves to be.

  1. Underperformance.
  2. From 1992 through 2002, growth-orientated mutual funds averaged 8.5% returns compared to an average annual return of 9.68% for the S&P 500 Index. Certainly, in any given year, some mutual funds outperform the market; however, the vast majority do not. Further, the average mutual fund investor will frequently sell an underperforming fund in an attempt to find that elusive ‘best performing’ fund which only incurs redemption fees, sales charges, and taxes which, in turn, drags their returns even lower.

  3. Transparency.
  4. Currently, mutual funds only report their holdings on annual, semi-annual, or quarterly basis. By the time, the fund owner is in possession of those reports, the fund’s holdings have likely changed dramatically. Further, it is a common practice for funds to ‘window dress’ their holding just prior to the release of a report. Transparency of fees and expenses is also a problem with mutual funds. While management fees and sales charges are widely accessible, other fees, such as 12b-1 and trading fees are often difficult to uncover. Most fund owners are not aware that each investment trade a mutual fund makes incurs a trading fee which is paid by the fund and further pulls downs the investors’ returns.

  5. Lack of Access to Your Money Manger.
  6. Most mutual fund investors know their broker or financial planner and regularly speak with them. However, these professionals have no control or influence over the underlying securities held by a mutual fund. The fund manager is ultimately in control of the investment selection, and the average investor has no access to this individual.

  7. Over-Diversification.
  8. Mutual funds are required by law to ‘diversify’ 75% of their assets. Diversification is defined as having no more than 5% of the portfolio in any single security and having no more than 10% of the outstanding shares of that security. Due to the size of some funds, many fund managers are forced to invest in more than 100 different stocks with the largest funds having positions in well over 175 stocks. Does that mean that the fund manager has 175 stocks that he thinks are ‘great buy opportunities’? Unlikely. The fund manager is often forced to buy lesser quality stocks in order to keep the fund ‘diversified’.

  9. Fund Overlap.
  10. Many mutual fund investors will place assets in several different funds. Perhaps the investor has bought a growth fund, a balanced fund and a small-cap stock. The investor would be surprised to find that many stocks held by one fund are also held by the other funds. However, this is often the case. The investor may have attempted to diversify across several funds only to find that he owns the same stocks over and over.

  11. Cash Requirements.
  12. The prospectus of a mutual fund will establish a minimum and maximum cash position the fund can take. The fund must adhere to this self-imposed requirement. This limits the fund managers investment options during market downturns. In longer ‘bear’ markets, most prudent investors would move their investments into greater cash positions. At the height of the market in the year 2000, the average mutual fund had only 4% of their portfolio in cash. This figure exceeded 6% only once for any given month during the following two-year bear market. The S&P 500 lost nearly half its value, but fund managers were forced to either keep a position in a stock that was plummeting in value or sell that stock and buy another stock that would likely lose value as well. To compound the problem, many of the stocks that were sold off by funds during the bear market, were sold at a net profit from their original purchase price even though they had declined in value that year. At the end of the year, investors had not only watched their portfolios decline in value rather dramatically, but they were also handed a capital gains tax liability. Speaking of taxes.

  13. Taxes.
  14. With Mutual Funds, an investor exposes themselves to two different tax situations. The first is capital gains tax on the increase in price of the fund above the investors cost basis in the fund. If an investor purchases a fund at $10 per share and then later sells the fund at $11 per share, the investor will pay capitals gains taxes on $1 per share. The second tax, often overlooked by investors, is the capital gains distributions that a mutual fund places upon its shareholders once a year. These distributions are not given to the shareholders that owned the fund at the time the capital gains was incurred, but rather to the shareholders at the time of distribution. When an investor purchases a fund, the investor is also assuming the tax liability for all capitals gains incurred since the last distribution. For example, ABC Mutual Fund sells a holding on May 1st for a gain. Jane Investor purchases 100 shares of ABC Mutual Fund on July 1st. John Investor, who originally purchased 100 shares of ABC Mutual Fund on January 1st, sells all of his shares on August 1st. Guess who gets to pay for that capital gain incurred on May 1st? Jane does when the distributions of capital gains are made later in the year. According to a release by the SEC in 2006, mutual fund investors lose 2.5% of their returns to taxes on embedded capital gains each year. While these taxes must be disclosed in a mutual fund’s prospectus, these taxes are often excluded from the returns the funds highlight in brochures and advertisements.

What alternatives do investors have to mutual funds?

For investors with over $100,000 of investable assets, separate accounts are an excellent alternative. These accounts are managed by professional money managers with whom the investor will often have direct access. In a separate account, the investor owns the underlying security; has greater control over when taxes are incurred; and has complete transparency of investments. Further, separate accounts have management fees that are often lower than mutual funds and have little to no expenses or additional fees which may affect portfolio performance.

Mutual funds are wildly popular and undoubtedly can make investors a profit. However, for the informed investor, separate accounts can achieve the diversification often sought in mutual funds while avoiding the inherent short-comings of mutual funds.

What is a Mutual Fund?

Mutual funds are investments vehicles which allow you to be broadly diversified by owning a large array of stocks or a particular investment instrument. Funds are managed by a single individual or a team of managers. Their job is to maximize your investment within the fund’s investment criteria. The decision made by the fund manager(s) will determine whether you see a financial gain or loss on your investment. Mutual fund managers are responsible for researching investments, as well as buying and selling securities. Mutual fund companies pool money from thousands of investors. Each of those investors becomes a shareholder in that fund.

Types of Mutual funds

There are literally thousands of mutual funds available for you to choose. Virtually every type of asset class is available at your fingertips. There are hundreds of sites which provide information on mutual funds. Morningstar.com is one of the largest and most comprehensive sites available. Popular types of mutual funds:

General Stock mutual funds-These types of funds can invest in a wide variety of stocks. These can range from large cap to small cap international stocks.

Emerging market mutual funds-These funds specialize in investing in small developing and emerging nations. Within these types of funds, you can find mutual funds that invest in a particular country such as Vietnam or India.

Sector funds-Do you think semiconductor stocks will do well in future? Do you think that the price of gold will continues to rise? Sector funds may be an ideal investment. Your manager can only invest in stocks in the particular sector you’ve chosen. If you chose a telecom sector fund and that particular segment of the market sees dramatic results, your telecom sector mutual fund should see similar gains. Sector funds have become extremely popular in the last several years. The thought process behind purchasing a sector fund is to obtain diversity while focusing on a single sector of the market you believe will outperform the market as a whole. You are also hiring a manager who is supposed to be an expert in the particular sector you’ve invested in. Generally sector funds have higher expenses than general funds.

Bond funds-Do you believe the bond market will outperform the stock market? Yes, bond funds are available and there is a wide variety to choose. There are short term Us Government bond funds, municipal bond funds, international bond funds, high yield (junk bond) funds..well you get the point.

Hybrid funds o further enhance your portfolio choices, you can elect to purchase a hybrid fund. Also known as balanced funds, these mutual funds typically invest anywhere from 50-70 percent in stocks and the reminder in bonds and cash. The managers of these funds typically have discretion how the fund will be balanced.

Index Funds-Index funds are generally passively managed funds designed to closely match their corresponding index. Index funds do not allow their fund manager the latitude of selecting or become overweight a particular stock or sector within the fund. It is their job to match the corresponding index The only time a mutual fund would sell a stock in a passively managed fun is if the corresponding was reconfigured. For example, when Microsoft was added to the S&P 500 Index, those mutual funds who mirrored the S&P 500 Index, were forced to purchase Microsoft so they would stay in lock step. Index mutual funds have three distinct advantages over actively managed funds.

1) Low turnover-This will minimize your tax burden at the end of the year. After all, it’s not how much money you make, it’s how much money you keep.

2) Low expenses-Low expense ratios let you keep more of your money. An index fund may be 5 times cheaper or more to manage than that of their actively managed funds

3) Over a ten year time period index funds have a huge advantage of those of active managed funds. If you are a large cap investor, you stand a 73% chance of receiving higher returns over an actively managed large cap mutual fund.

Drawbacks to index funds

With their advantages over actively managed mutual funds, index funds do have a drawback. Since every fund has management expenses, you stand to NEVER beat the index you are trying to meet or outperform. If you want large cap exposure and decide to purchase Vanguard’s Index 500 mutual fund, you will lag the S&P. If Vanguard’s expense ratio was.2% and the S&P 500 return was 10% for the year, your return will be 9.8%.

While expenses are a drawback, you simply cannot acquire diversification for free. Everything comes with a price and investing is no different.

There are vast universes of investment choices available which can enhance your return. While it is difficult to beat the S&P 500, with the correct combination of index funds and proper asset allocation, it is possible to achieve superior returns. This takes know how, experience and nerves not to sell out when the market corrects. A good financial planner will be able to provide you all of these required skills.

What’s a Mutual Fund?

Mutual funds are pools of money. Money from many different individual investors can be pooled with money from, say, the retirement fund of a global corporation.

This money is managed full time by professionals who are paid for their financial management expertise.

Mutual funds invest in a portfolio of stocks (equities), bonds, or money market instruments. You, the shareholder, own a proportionate part in much the same way you would be an owner of a company in which you buy stock.

If a stock fund invests in the stocks of 50 companies, you own a part of those 50 companies. You share ownership with other individuals and sometimes with institutional investors.

Investing in mutual funds has similarities to investing in stocks, but there is one difference: Most funds are “open-ended.” An open-ended fund is one in which there is no fixed amount of shares outstanding.

Investors can buy shares in an open-ended mutual fund at any time, and in unlimited quantities, as long as the fund is open to new investments. This is in contrast to stocks and closed-end mutual funds, which issue a certain number of shares.

The Advantages of Mutual Fund Investing

Diversification: When you invest in a mutual fund, you get instant diversification of your holdings by owning a part of each company that your fund invests in.

Professional Management: Fund managers have more time, expertise, and resources to manage investments than most individual investors do. However, managers have widely varying levels of experience and different track records, which you should examine carefully.

Convenience: They provide a great deal of convenience for busy investors. Not only is it fairly easy to purchase fund shares, but they also offer automatic transfers and reinvestments of dividends and capital gains. You can also transfer your money from one fund to another.

Selection: There is a fund available for virtually any type of market sector that you might be interested in. A mutual fund screener is a good way to find high-quality funds for your portfolio. There are also mutual fund newsletters that provide investors with fund profiles and information.

Liquidity: They offer an important combination of appreciation potential plus liquidity. Shares can be redeemed at the end of each day, based on the fund’s net asset value (NAV).

Concise information: Based on mandates from the Securities and Exchange Commission (SEC), fund companies are obligated to provide a simple, easy-to-understand prospectus and investor reports. A prospectus spells out a fund’s goals, strategies, fees, and expenses. The shareholder report describes the fund’s most recent performance.

Protection: While investors are not insured against investment loss, rules do exist that regulate mutual fund transactions, advertising, and communications with investors.

The Disadvantages of Mutual Fund Investing

No guarantee: As previously noted, mutual fund investors are not protected by any guarantees against losses in their fund investments. Stock funds invest in stocks, and the stock market rises and falls. Individual holdings within a fund, and individual funds, fluctuate in value.

Objectives: There are several investment information companies that categorize funds by their investment objective. Make sure that your fund manager invests according to the stated objective. Some funds drift away from their stated objective, and your money could be sitting idle as cash or being invested in different types of securities than the fund’s objective states.

Diversification: Yes, diversification is both an advantage and disadvantage in mutual fund investing. Although investing in a large number of companies through a mutual fund can help insulate you from taking a huge loss in the stock market, it also prevents you from realizing a large gain that a smaller portfolio might realize.

Fees: Fees vary widely from fund to fund, and, in many cases, exceed the cost of employing a full-cost broker. Be aware of front-end sales charges, back-end sales charges, and ongoing operating expenses that cut into your returns.

Capital gains: Unless your investment is in a tax-sheltered account, you will be obligated to pay capital gains tax on the distributions you receive. By law, a fund’s capital gains are passed on to shareholders, who must pay tax on them.

How a Typical Mutual Fund Is Structured

They are structured as a corporation or business trust. Shareholders receive regular statements and reports.

The fund itself has no employees. An independent board of directors oversees a fund.

An investment adviser or management company is hired to manage the fund’s holdings and make all buy and sell decisions.

Shareholders do not participate in portfolio management decisions, although they may receive notice of meetings and may be asked to vote on issues related to the fund owner.