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Mutual Fund

Mutual Funds
Introduction
Wealthy individuals and institutions have always had access to professional money managers. They also have the wherewithal to properly diversify their holdings. These are the two major disadvantages for the small time individual investor the relatively small size of their portfolio does not allow them to properly diversify and most top money managers require a minimum of $250,000 (or more) to open an account. Mutual funds provide the answer for the individual investor. Most have very low initial investment requirements and some have no minimum requirement at all you can start investing with as little as $100.00 or even less.

Mutual Fund Definition:

A mutual fund is made up of money that is pooled together by a large number of investors who give their money to a fund manager to invest in a large portfolio of stocks and / or bonds.

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What is a Mutual Fund and How does these work?

Mutual fund is a kind of trust that manages the pool of money collected from various investors and it is managed by a team of professional fund managers (usually called an Asset Management Company) for a small fee. The investments by the Mutual Funds are made in equities, bonds, debentures, call money etc., depending on the terms of each scheme floated by the Fund. The current value of such investments is now a days is calculated almost on daily basis and the same is reflected in the Net Asset Value (NAV) declared by the funds from time to time. This NAV keeps on changing with the changes in the equity and bond market. Therefore, the investments in Mutual Funds is not risk free, but a good managed Fund can give you regular and higher returns than when you can get from fixed deposits of a bank etc.

How to Profit with Mutual Funds?

When you invest in a mutual fund you hope that the value will rise and you can eventually sell your shares for a profit. This is one of the ways you can profit with mutual funds. Another way is through capital gains. When a mutual fund sells a security for a higher price than it originally paid for it, it is known as a capital gain. Most mutual funds distribute their capital gains to shareholders at least annually, some more often. The last way to profit with mutual funds is with dividends or interest. If the fund has invested in bonds or dividend-paying stocks, it must pass the dividends or interest earned on to its shareholders. Like capital gains, this is done at least annually.

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Net Asset Value (NAV) :When you invest your money in a mutual fund, you buy shares in that fund. To determine the price of those shares, each day the fund adds up the total value of the securities held in its portfolio. This total is divided by the number of shares outstanding. The resulting figure is known as the Net Asset Value or NAV. To find out the value of your holdings, you simply multiply the number of shares you own by the net asset value. The NAV of most funds is listed in most daily newspapers. The NAV will change daily depending on how well the underlying securities of the fund perform. If the securities held by the fund go up in value so will the value of your shares.

Open End & Closed End Mutual Funds :As stated above, mutual funds are generally classified according to the investment objective of the fund. They are also classified according to how they are bought and sold. There are open- or closed-end funds and there are load or noload funds. An open-end mutual fund is a mutual fund that continuously issues new shares as needed and buys them back when investors wish to sell. There is no limit to how many shares an open-end fund can sell. The buy and sell price is based on the net asset value of the fund. The majority of mutual funds on the market today are open-end funds and are the type we are concerned with in this tutorial. The characteristics of a closed-end mutual fund more closely resemble that of an individual stock. A closed-end fund is a mutual fund that issues a fixed number of shares which are then traded (bought and sold) on a stock exchange or
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over the counter. Although the underlying value of the securities in a closed-end fund may be, for example, $10.00 per share, they may sell for more or less depending on investors outlook for the future value of the securities.

Some of the terms used in mutual funds:1. Net Asset Value (NAV):Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date. 2. Sale Price:It is the price you pay when you invest in a scheme and is also called "Offer Price". It may include a sales load. 3. Repurchase Price : It is the price at which a Mutual Funds repurchases its units and it may include a back-end load. This is also called Bid Price. 4. Redemption Price : It is the price at which open-ended schemes repurchase their units and closeended schemes redeem their units on maturity. Such prices are NAV related. 5. Sales Load / Front End Load : It is a charge collected by a scheme when it sells the units. Also called, Frontend load. Schemes which do not charge a load at the time of entry are called No Load schemes. 6. Repurchase / Back-end Load : It is a charge collected by a Mutual Funds when it buys back / Repurchases the

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units from the unit holders.

Types of mutual funds:Most funds have a particular strategy they focus on when investing. For instance, some invest only in Blue Chip companies that are more established and are relatively low risk. On the other hand, some focus on high-risk start up companies that have the potential for double and triple digit growth. Finding a mutual fund that fits your investment criteria and style is important.

Types of mutual funds are:

y Balanced Funds :These funds are probably best for conservative investors (those who try to minimize their risk). These funds often invest in many different stocks and bonds. Some balanced funds invest in over 200 stocks. By doing this, they minimize your risk while also providing fairly stable growth. y Dividend Growth :These mutual funds use a special kind of investing strategy. They look for stocks that pay dividends and determine the health of the company by seeing how fast the dividend payments are growing. When a company is doing well, it often raises its dividends. The fund managers look at these as the key factor in deciding which stocks to buy. Companies that pay dividends are often large, well-established companies.

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Therefore, dividend growth funds are fairly safe investments but they also provide quite a bit of growth. y Capitalization Funds :These funds invest in companies whose market capitalization (the total value of all of their stock) falls into their area. Small-cap stocks are those that have market caps of less than $1 billion. Mid-cap stocks are those with market caps in the range of $1-5 billion. Large-cap stocks are those with market capitalizations of atleast $5 billion. Of all of these funds, small-caps are the most risky beause they invest in many small and new companies but their potential is also the greatest. When it comes to low risk long-term investing, mid-cap and large-cap mutual funds are probably the best because those stocks provide the most stable growth. y Index Funds :Index funds are seen as the best type of mutual funds to invest in because they outperform 85% of all mutual funds. These funds invest in stocks that make up stock indexes such as the S&P 500. These funds also have fewer fees because they buy and sell stocks less often. Also, because they sell stocks less often, the capital gains are usually seen as long-term so you will pay less when tax season comes around. With these factors in consideration, index funds are excellent for long-term investing. y Sector Funds :These are specialty mutual funds that invest in stocks that fall into a certain sector of the economy. For example, the T. Rowe Price Health Sciences fund invests in health care, life sciences, and pharmaceutical stocks. These funds usually have the highest potential for gains but also carry
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considerable risk. If the sector that the mutual fund invests in does poorly, the mutual fund will be hurt pretty bad because it doesn't have the option of moving money to another sector.

y Growth and Income :Growth and Income funds are mutual funds that are a mix between income (bond) funds and growth (stock) funds. These funds split their holdings between bonds and stocks to try to give investors stable income through bonds as well as growth through stocks. These funds perform pretty well but because they hold a large amount of bonds, they are probably better for investors who are less willing to take risk or those who are nearing their financial goal (such as retirement). Hopefully, this has helped you decide what mutual fund objective best suits you without having to spend all of your time researching the thousands of mutual funds on your own.

Advantages of Mutual Funds:

Professional Management : The primary advantage of funds (at least theoretically) is the professional management of your money. Investors purchase funds because they do not have the time or the expertise to manage their own portfolio. A mutual fund is a relatively inexpensive way for a small investor to get a full-time manager to make and monitor investments.

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Diversification :
By owning shares in a mutual fund instead of owning individual stocks or bonds, your risk is spread out. The idea behind diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains in others. In other words, the more stocks and bonds you own, the less any one of them can hurt you (think about Enron). Large mutual funds typically own hundreds of different stocks in many different industries. It wouldn't be possible for an investor to build this kind of a portfolio with a small amount of money. Economies of Scale : Because a mutual fund buys and sells large amounts of securities at a time, its transaction costs are lower than you as an individual would pay.

Liquidity :
Just like an individual stock, a mutual fund allows you to request that your shares be converted into cash at any time.

Simplicity :
- Buying a mutual fund is easy! Pretty well any bank has its own line of mutual funds, and the minimum investment is small. Most companies also have automatic purchase plans whereby as little as $100 can be invested on a monthly basis.

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Disadvantages of Mutual Funds:

Professional Management :Did you notice how we qualified the advantage of professional management with the word "theoretically"? Many investors debate over whether or not the so-called professionals are any better than you or I at picking stocks. Management is by no means infallible, and, even if the fund loses money, the manager still takes his/her cut. We'll talk about this in detail in a later section.

Costs
Mutual funds don't exist solely to make your life easier--all funds are in it for a profit. The mutual fund industry is masterful at burying costs under layers of jargon. These costs are so complicated that in this tutorial we have devoted an entire section to the subject.

Dilution :
It's possible to have too much diversification (this is explained in our article entitled "Are You Over-Diversified?"). Because funds have small holdings in so many different companies, high returns from a few investments often don't make much difference on the overall return. Dilution is also the result of a successful fund getting too big. When money pours into funds that have had strong success, the manager often has trouble finding a good investment for all the new money.

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Taxes :
When making decisions about your money, fund managers don't consider your personal tax situation. For example, when a fund manager sells a security, a capitalgain tax is triggered, which affects how profitable the individual is from the sale. It might have been more advantageous for the individual to defer the capital gains liability.

Various Uses Of Mutual Funds :Mutual funds have a wide variety of uses for savings and investing. Their are mutual funds that can be used for short-term savings and long-term savings. Most are for long-term savings.

Savings Accounts: Short term - An example of a very short-term savings account ( 6 months-one year), could be a money market mutual fund or income fund. Mid term - An example of a mid- term savings account (2- 3 years) could be an income -equity fund. Long- term - An example of long-term (greater than 3 years) could be a growth or growth and income mutual fund. Very long-term - an example of very long term, (five years or more) are growth, growth and appreciation, growth and income, and international funds. Retirement accounts: Retirement accounts are long-term accounts, so example's of mutual fund types appropriate for these accounts would be growth, growth appreciation, international, growth and income or a combination of these funds.
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College Plans: Hopefully you will have at least 10 years to invest for college, the longer the better. If you don't have ten years do the best you can. The fund choices will be similar to retirement funds. Use our financial calculators (College Funding Calculator ) , to calculate funds needed for college. Many mutual fund companies have specific college funds. It is best to start saving for college when your children are babies. You can also save for college in a ROTH IRA, funded with mutual funds. This is also true with other investments. Mutual funds work best when held long term.

Mutual Fund Services Not all Mutual Funds are equal and many have great services. There are many different types. Know what you are getting and what services are offered before you invest your money. Request and READ the prospectus before you invest, ask questions to customer support before you start.
y

You can direct deposit monthly payments from your checking

account into your mutual fund account.

y

You will receive organized monthly or quarterly statements

delivered by U.S. mail or your computer online service.

y

Mutual fund companies have an 800# to answer questions, order

prospectus, transfer money to your checking account.

y

There can be several funds in a fund family, most will allow

switching between funds at no additional cost.

y

Mutual fund companies offer diversification of investment with

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small amounts of money.

MUTUAL FUND Technically, mutual funds are open-end funds -- one of four basic types of an investment company. Closed-end funds, exchange-traded funds and unit investment trusts are the three other types. In order to understand the structure of mutual funds, it is helpful to compare them to other 40 Act Funds -- industry jargon for investment companies registered under the Investment Company Act of 1940. Open-End Funds and the Structure of Mutual Funds You can think of a mutual fund as having an open-end structure because the cash flow door -- both into and out of the fund -- is always open. In other words, the portfolio manager continues to invest new cash from investors, and the fund company continues to offer new shares of the fund to new investors. So, when you invest in a mutual fund, money is directed to the mutual fund, shares are created and issued to you (to be held in an account at a brokerage firm, bank or at the fund company). This process is different from investing in a stock. When you invest in a stock, you are buying or selling shares on an exchange or over-the-counter (unless it is an initial public offering or a secondary offering) new shares are not be created. Closed-End Funds and the Structure of Mutual Funds Closed-end funds are often confused with, and mistakenly called, mutual funds. They are similar to open-end funds in that their assets are invested in a wide range of securities. A major difference is that closed-end funds behave more like a stock -- the market value is driven by supply and demand for the shares. On the other hand, an open-end mutual fund continually issues new shares to investors and does not trade on an exchange.

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ETFs and the Structure of Mutual Funds ETF is short for "Exchange-Traded Fund." An ETF holds a basket of securities and trades on a stock exchange. The market value of an ETF changes throughout the day based on the supply and demand for each individual ETF. The net asset value (value of the securities within the fund) of an ETF may differ from the market value (price that an investor purchases/sells the ETF) due to the supply and demand effect. UITs and the Structure of Mutual Funds UITs can be thought of as a hybrid investment; sharing some of the qualities of mutual funds and some of the qualities of closed-end funds. UITs are similar to mutual funds in that an investor can redeem shares (versus trading on a stock exchange) from the UIT sponsor. But unlike mutual funds, UIT sponsors might also maintain a secondary market in the UIT. In other words the UIT sponsor might facilitate buys and sells between investors in order to avoid depletion of the UITs assets. UITs, like closed-end funds, issue a set number of shares. These shares are called units. Unlike closed-end funds (and open-end funds), the securities within a UIT portfolio are not actively-traded. A UIT portfolio is established at the inception date and holds the original securities until termination of the UIT. At the termination date the UIT shareholders either receive the proceeds of their investment or they can reinvest in the

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Why are Mutual Funds so Popular?

Mutual funds provide an easy way for small investors to make long-term, diversified, professionally managed investments at a reasonable cost. If an investor only has a small amount of money with which to invest, then he/she will most likely not be able to afford a professional money manager, a diversified basket of stocks, or have access to low trading fees. With a mutual fund, however, a large group of investors can pool their resources together and make these benefits available to the entire group. There are no perks for the largest investor and no penalties to the smallest--all mutual fund holders pay the same fees and receive the same benefits. Mutual funds are also popular because they provide an excellent way for anyone to direct a portion of their income towards a particular investment objective. Whether you're looking for a broad-based fund or a narrow industry-focused niche fund, you're almost certain to find a fund that meets your needs. Although the various
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style and category types are virtually endless, here's a quick summary of some of the various choices available to equity investors:

Broad-Based Funds :
Investors can use mutual funds to gain exposure to the broad U.S. stock market. A number of funds track such well-known indices as the S&P 500 and Dow Jones Industrials, as well as even broader indices like the Wilshire 5000.

Market Cap Oriented Funds :

Some funds invest exclusively in stocks of a particular size, such as large-caps (generally defined as companies with market caps of at least $10 billion), mid-caps ($1-$10 billion), small-caps ($300 million to $1 billion) or micro-caps ($50-$300 million).

Investment Style/Objective Funds :

Some funds invest primarily in value-oriented stocks. Meanwhile, others are much more aggressive, investing exclusively in growth companies. Still others invest in income-oriented issues. The different investment styles and objectives to choose from are virtually endless.

Industry/Sector/Niche Funds
Certain funds specialize in one particular industry. For example, some funds invest in Biotech stocks, while others invest only in gold & silver companies, etc. Meanwhile, other funds focus exclusively on niche markets, such as companies that are going through mergers or IPOs (initial public offerings).
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Country/Region Specific Funds :-Investors can use mutual funds to gain exposure to equities based in a particular country (Brazil, China, etc) or region (Europe, North America, etc), as well as broad exposure to stocks all over the world.

Actively Managed vs. Index Funds :-Some funds are actively managed by professional money managers. Meanwhile, others are passively-managed funds that track a particular index or hold a fixed basket of stocks. Another advantage of mutual funds is that they usually make it very easy to invest small sums of money on a regular basis. In fact, many funds allow investors to make automatic deductions right from their bank accounts or paychecks. And finally, another reason for the popularity of mutual funds is that many investors simply cannot afford to properly diversify and manage their portfolio throughout the year. To achieve the best results from diversification, a portfolio needs to contain at least 30 holdings. Instead of going out and purchasing 30 different stocks and managing them all year, an investor can just buy shares in a mutual fund and let the manager take care of all of the day-to-day decisions.

What are some drawbacks to Mutual Funds?

As mentioned above, fees can be a serious impediment to mutual funds. In fact, some of the costliest funds may charge 4-5% per year in fees. Any fund that charges
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high fees will undoubtedly claim that it does so in an effort to provide superior management. While this may occasionally be true, it is rarely the case. Studies have shown that in the long run, most mutual funds underperform the overall market by exactly the same amount they charge in fees. With this in mind, we suggest finding funds with low expense ratios and no front- or back-end loads. A fund that charges 2% per year will cost you $200 for every $10,000 that you have invested. Unless the fund can outperform the market by 2%, you will have unwisely paid the manager extra money when you could have put that same money into your own portfolio. Index funds generally provide the overall lowest costs because they do not actively manage their holdings (this lowers managerial and transaction costs). These are often referred to as passively-managed funds because they simply track a predetermined index such as the S&P 500, Dow Jones Industrials, or the Nasdaq Composite.

International Mutual Funds:

Investing in international mutual funds is gaining popularity for various reasons. Rising political stability merging or opening of borders and currencies are some of the reasons. Vibrant and upcoming economies and non US corporations becoming financially stronger by the day are some of the reasons. This article includes: How one can invest in international mutual funds? Why the number of funds in the international investing is on the rise? What are the points to be analyzed before investing in international

mutual funds?

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Look at the GDP (gross domestic product) growth of US which while being good enough for an advanced economy is a pale shadow of growth of GDPs of now developing countries. A spell binding performance of almost one and a half decades has faded into sidelines in comparison with the overseas stock markets. Two reasons stand out for this interesting phenomenon. Higher average age of US investors forces them into concentrating on

mutual funds like retirement plans (401 (k)) rather than the aggressive stock or index funds. US have highest percentage (48%) of invested public (5 times more than

Japan and about twice more than Europe). This vacuum coupled with higher growth rate of GDP is attracting the investment outside US. Investing In International Mutual Funds Investing in international mutual funds has two faces. First is buying funds from US based companies that buy and manage

portfolio in internationally listed stocks/securities. These companies are governed by regulations of SEC (Securities and Exchange Commission) Second is buying mutual funds from international non US companies.

A word of caution before investing even in best international mutual funds Unlike domestic mutual funds investment, international investments entail additional risk factors such as economic and political in addition to risk of FOREX value (simply put: foreign currency exchange value) fluctuations. Why Should You Invest In International Opportunities? The number of funds in international investing is on the rise. We can cite a few
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reasons for this. Removal of trade barriers and expanding of economies have sparked off

growth in many non US companies. companies. Over 72% of the world stocks are listed out side US. Greater and true diversification and opportunity to capitalize on best Some of the major industries of the world are dominated by non US

overseas companies. Investing in international mutual funds is gaining popularity for various reasons. Rising political stability merging or opening of borders and currencies are some of the reasons. Vibrant and upcoming economies and non US corporations becoming financially stronger by the day are some of the reasons. In addition you get true diversification, balance and opportunities.

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