Wednesday, December 3

Mutual Fund overview



MUTUAL FUND OVERVIEW
What is a Mutual Fund?
A mutual fund is a pool of money that is professionally managed for the benefit of all shareholders. As an investor in a mutual fund, you own a portion of the fund, sharing in any increases or decreases in the value of the fund. A mutual fund may focus on stocks, bonds, cash, derivatives or a combination of these asset classes.
There are different types of mutual funds. Some mutual funds are riskier than others. For example, it is unlikely that you will lose money in a mutual fund that buys money market instruments, such as treasury bills. Risk can sometimes work in your favor: the higher the risk, the bigger the potential return (and the bigger the potential loss); the lower the risk, the smaller the potential return (and the smaller the potential loss). To reduce your overall risk and enhance potential returns, you should invest in a diversified portfolio of mutual funds which have different risk characteristics. An investment in a Fund is a convenient method to achieve that diversification.

Advantages of Mutual Fund:
Mutual funds offer a number of advantages, including diversification, professional management, cost efficiency and liquidity.
*Diversification. A mutual fund spreads your investment dollars around better than you could do by yourself. This diversification tends to lower the risk of losing money. Diversification usually results in lower volatility, because when some investments are doing poorly, others may be doing well.
*Professional management. Many people don't have the time or expertise to make investment decisions. A mutual fund's investment managers, however, are trained to search out the best possible returns, consistent with the fund's strategies and goals.
*Cost efficiency. Putting your money together with other investors creates collective buying power that may help you achieve more than you could on your own. As a group, mutual fund investors can buy a large variety and number of specific investments. They can also afford to pay for professional money managers and fund operating expenses, where they wouldn't be able to afford it on their own. *Liquidity. With most funds, you can easily sell your fund shares for cash. Some mutual fund shares are traded only once a day at a fixed price, while stocks and bonds can be bought or sold any time the markets are open at whatever price is then available.

Buying shares (Investment Procedure)
You can buy shares a few different ways, depending on the rules of the particular fund. Funds are often described as either being "no-load" or "load" funds, depending on whether or not they charge a sales commission.
No-load funds: Many funds are no-load funds that charge no (or a very low) sales fee or commission. Financial companies typically sell no-load funds directly to investors in places like newspapers and magazines. In this case, you complete all the paperwork yourself.
Load funds: These funds charge a sales fee or commission for purchases. Some funds charge the fee when you buy shares; others charge when you sell them. Brokerage firms and banks often sell load funds, and will help process any paperwork.
There are reputable, high-performing funds in both categories. Because sales charges reduce your return, we believe that investors should consider no-load funds whenever possible.
Funds typically give you two ways in which to invest:
Lump sum. You can invest any amount you want at one time, as long as you meet the minimum requirements of that fund. Some funds have no minimum for opening an account or no minimum for additional share purchases, while others do.
Automatic investment. Most funds offer plans that allow you to transfer set amounts on a regular basis automatically from your bank account or paycheck.
With automatic investing, you get the benefits of dollar cost averaging. That is, when you make regular investments in a mutual fund, such as investing $100 every month, you can take advantage of both the ups and downs of the market. When the market is down, your monthly investment typically buys you more shares of the fund, helping to increase your ownership in the fund. When the market is up, your monthly investment typically buys you fewer shares of the fund, helping you avoid buying too many shares at higher prices. Over a long period of time, the end result is that the average cost of your fund shares is lower than the average price of the fund shares during the same period.
Exchanging and selling shares
Many funds allow you to make free exchanges of your shares for shares of another fund owned by the same fund company. Typically, there is a limit to the number of free exchanges you can make. Be aware that even though an exchange may be free, there may be tax consequences associated with it.
To sell shares, you either call the fund directly if you have a no-load fund, or have your broker or bank officer do it if you have a load fund. Typically, you are given the option to have the proceeds deposited into your account or sent directly to you by check or wire. Some funds will charge you a fee if you don't keep the fund shares for a minimum amount of time (e.g., 90 or 180 days).

Pricing Methodology:
The value of a mutual fund share is calculated based on the value of the assets owned by the fund at the end of every trading day. Here is how it works:
The fund calculates the value: A share's value is called the Net Asset Value (NAV). The fund calculates the NAV by adding up the total value of all of the securities it owns, subtracting the expenses of the fund, and then dividing by the number of shares owned by shareholders like you.
Value changes daily: Since the value of the stocks or bonds owned by the fund can change daily, the value of the fund can also change daily. Therefore, a fund is required by law to adjust its price once every trading day to provide investors with the most current NAV.
How many shares you own: To see the value of your investment, you take the value of one share and multiply it by the number of shares you have in the fund. While you cannot buy a fraction of a share of stock, you can own a fraction of a mutual fund share, if the amount you invest does not divide evenly by the NAV.

Earnings:
Once your money is in a fund, it can provide you with earnings in three ways.
Appreciation: The value of a fund share can appreciate or go up in value. (Of course, it can also go down in value.) When the total value of the securities owned by the fund rises, the value of your fund shares rises with it. Again, the reverse is also true.
Dividends: If the fund receives dividends from stocks, interest from bonds, or other investment income, it distributes those earnings to shareholders as a dividend according to the terms outlined in its prospectus. Depending on the fund, these distributions can be monthly, quarterly, or annually.
Capital gain distributions: Every time the fund manager sells securities at a profit, the fund earns capital gains. Funds are required to distribute these gains to the shareholders at regular intervals, typically once or twice a year


Choosing a Mutual Fund
Choosing the right funds—and trusting your decisions enough to back them with your money—is challenging. Factors to be considered while investing in Mutual Fund are enumerated below:
Look at the fund prospectus.The prospectus is essentially the user's manual for a mutual fund. The SEC requires every fund to publish a prospectus and update it annually. It covers all of the important elements, such as the history, management, financial condition, performance, expenses, goals, strategies, types of allowable investments, and policies.

Performance. Each fund must tell you how much it has increased or decreased in value in each of the past 10 years (or for every year of its existence, if shorter). This is labeled in the prospectus as "performance" or as "annual total return." Fund performance is required to be shown against a relevant industry benchmark.

Average annual return. While every fund has to show its annual performance, every fund also must tell you its average return on a yearly basis. Average annual return is important because it keeps funds from promoting their best years and ignoring their worst years. It takes the total returns for each year and averages them across the number of years the fund has been in existence.

Fees and expenses. The prospectus will tell you if a fund charges a sales charge or is a "no-load" fund. All funds charge management fees and expenses, which will be described in the prospectus.

Use independent rating services. Independent rating services, such as Morningstar, Lipper and Barrons, often provide a convenient way to find out information about a fund very quickly. These services typically provide you with a rating or ranking of a fund based on its performance relative to its broader peer group, as well an opinion about a fund's management team and operations.

Risks
You could lose money
It's the most obvious and feared risk of investing. There are, however, many strategies for managing this risk, particularly over the long term.
Your money may lose buying power
This risk is also known as inflation risk: as prices increase, your investments must increase in value at least at the same pace, or you'll lose purchasing power.
You may not achieve your goal
Probably the biggest, yet most overlooked risk of investing, is the risk of not achieving your goal. It's probably overlooked so often because so few investors actually set goals, and many others set unrealistic goals. Furthermore, many investors don't buy the right investments to help them achieve their goals. This type of risk is often called shortfall risk (falling short of your goal).
Your investment may rise and fall in value
Almost all investments have the potential to gain and lose value. This is known as market risk. Seasoned investors tend to ignore the relatively small price movements in their investments, preferring to try and capture the more significant fluctuations they can better anticipate. If you invest for longer periods of time, market risk may become less dangerous to you. That's because, over the long-term, most investments tend to rise in price. Market risk, however, can place investors at a significant disadvantage if they are forced to sell at a time when prices happen to be down.
Foreign exchange or currency risk
If you invest overseas, the exchange rate between your home currency and the foreign currency adds an extra layer of risk to your investment. The stock or bond you buy may go up, but the exchange rate may go down so far that it wipes out your gain.
The halo effect
When something wonderful happens to one stock in an industry, many of the others in that industry may also enjoy a rise. This is known as the Halo Effect. But it also occurs in reverse, taking value out of perfectly good investments just because they are linked in the minds of investors to another investment that is experiencing a problem.

Different Types of Funds
Mutual funds come in a wide variety of investment styles. The most common are money market funds, stock funds, bond funds and mixed asset funds.
Money market funds
Aiming for protection, money market funds are considered the safest place to invest money in mutual funds. They do not provide much potential for income or growth. However, they do seek to generate a small amount of return by loaning money on a short-term basis, anywhere from one day to up to a year. These loans are considered low-risk because they are such short-term. On the other hand, they are also typically the class of fund that earns the least for investors. Money market funds charge low interest rates for the loans, thus earning you small amounts on your investment. Money market funds try to maintain a consistent share price of $1 by paying out all of the earnings to shareholders and by avoiding securities that can rise and fall in price (so there are no capital gains to distribute).
You have a choice of varieties of money market funds:
Taxable
: These are simply called "money market funds" if offered by a mutual fund company; or "money market accounts" if offered by a bank. Both make short-term loans, but those offered by a bank are FDIC (Federal Deposit Insurance Corporation) insured. Those offered by mutual funds are insured by the private insurer, SIPC (Securities Investors Protection Corporation).
Government: These funds only make loans to national governments or agencies of those governments. Earnings are free from federal taxation.
Municipal: These funds only make loans to various state and local governments and their agencies. The income from these funds is free from federal taxation, and any portion of the income that comes from the state in which you live is also free from state taxation.

Bond Funds.

Aiming for income, bond funds loan money to corporations and/or government agencies. Bond funds are typically for earning a somewhat predictable amount of income. In times of falling interest rates, however, a bond fund could increase in value, growing your money through capital appreciation, as stock funds are meant to do. The opposite is also true; in times of rising interest rates, the bonds in your fund may lose value and cause you to lose money, even while you're earning income from interest.
The different types of Bond Funds available are as follows:
Corporate bonds: a corporation is the borrower
Government bonds: the national government or its agency is the borrower
Municipal bonds: a state or local government or its agency is the borrower
Short-term bond funds: bonds typically maturing in less than five years
Intermediate bond funds: bonds typically maturing in five to ten years
Long-term bond funds: bonds typically maturing in ten to thirty years

Stock Funds
Stock funds generally aim for growth, income or a combination of both. A stock fund invests mainly in stocks and may focus on a particular type of stock or segment of the stock market, depending on its goal and strategy.
Various Stock Funds available are as follows:
Aggressive growth. These are the start-up, or relatively new companies who have not yet established themselves in their product or service market. They may also be companies in high risk businesses, such as the Internet, biotechnology, and a number of other highly competitive and money-intensive industries.
Growth. These are companies that have moved beyond the phase of uncertainty but still have a lot of room to grow.
Value. These are well-established companies with histories of consistent earnings and growth, whose stock prices are viewed by the portfolio manager as being an attractive value.
Industry and sector. Some industries will do well while others will do poorly. The companies in the software business are in the same industry; while others in the high tech hardware business are in a different industry. All of these companies, however, would be grouped into the high tech sector.
Country or region. The economies of different countries act differently at different times. So there are mutual funds, for instance, that invest in specific countries or regions. The term "emerging growth fund," describes a fund that invests in countries that have small but growing economies.

Balanced funds
Balanced funds aim for the best of both stocks and bonds. These funds mix stocks and bonds to give you a mixture of growth potential and income potential, as well as a little more protection during periods of dropping prices. The stocks are typically meant to provid price appreciation potential, while the bonds are meant to provide income and a measure of price stability.Balanced funds may either keep their ratio of stocks to bonds fairly constant or switch the ratio of stocks to bonds depending on market conditions.

Asset allocation funds
Asset allocation funds can invest in a mixture of stocks, bonds and cash equivalents. The ratio of each asset class is typically based on investor risk profiles, such as conservative, moderate and aggressive.


Index funds
Index funds are low-cost mutual funds that seek to mirror the performance of the broader markets they represent.

Lifestyle Funds
These funds aim to provide all the diversification that you need in a single fund. They are designed for consumers who don’t have much time or knowledge to make investment decisions. They can go by a number of different names, such as retirement, target date (e.g., target date 2040), life-cycle or asset allocation funds.

Exchange traded funds (ETFs)
Exchange Traded Funds are baskets of stocks, somewhat like mutual funds, that are traded on the stock market. The fees may be even lower than mutual funds, and the tax consequences more favorable.But you pay a commission to buy them, just like when you buy stocks. So, if you want to invest on a regular basis, ETFs can get very expensive because you pay a commission every time you buy more shares.

Open-ended and Closed-ended fund
The term mutual fund is the common name for an open-end investment company. Being
open-ended means that, at the end of every day, the fund issues new shares to investors and buys back shares from investors wishing to leave the fund. Mutual funds may be legally structured as corporations or business trusts but in either instance are classed as open-end investment companies by the SEC. Closed end funds are generally listed funds and can be traded on exchanges just like shares. However, they can be issued and redeemed on specific dates only, and thus the name 'closed end'. The ownership of closed ended funds can transferred from one holder to another.

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