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Mutual Funds
Mutual
Fund Basics
This information offers a basic introduction to mutual funds. It can help you decide if a mutual fund might be a good choice for you as an investment. If you visit a big fund company's web site (e.g., www.xyzfund.com), they'll tell you that a mutual fund is a pool of money from many investors that is used to pursue a specific objective. They'll also point out that the pool of money is managed by an investment professional. A prospectus (see below) for any fund should tell you that a mutual fund is a management investment company. But in a nutshell, a mutual fund is a way for the little guy to invest in, well, almost anything. The most common varieties of mutual funds invest in stocks or bonds of US companies. First
let's address the important issue: how little is our
proverbial little guy or gal? Well, if you have $20 to
save, you would probably be better advised to
speak to your neighborhood bank about a savings
account.
Most mutual funds require an initial investment of at least $1,000. Exceptions to this rule generally require regular, monthly investments or buying the funds with IRA money and this can be risky. Next, let's clear up the matter of the prospectus, since that's about the first thing you'll receive if you call a fund company to request information. A prospectus is a legal document required by the SEC that explains to you exactly what you're getting yourself into by sending money to a management investment company, also known as buying into a mutual fund ( but wait how do I understand it - most do not ). The information most useful to you immediately will be the list of fees ( which are often times hidden ), i.e., exactly what you will be charged for having your money managed by that mutual fund. The prospectus also discloses things like the strategy taken by that fund, risks that are associated with that strategy, etc. etc. Have a look at one and you will start scratching your head. The
worth of an investment with an open-end mutual fund is
quoted in terms of net asset value.
Basically, this is the investment company's best assessment of the value of a share in their fund, and is what you see listed in the paper. They use the daily closing price of all securities held by the fund, subtract some amount for liabilities, divide the result by the number of outstanding shares and Poof! you have the NAV. The fund company will sell you shares at that price (don't forget about any sales charges ) or will buy back your shares at that price ( possibly less and some fees ). Although boring, you really should understand the basics of fund structure before you buy into them, mostly because you're going to be charged various fees depending on that structure. All funds are either closed-end or open-end funds . The open-end funds may be further categorized into load funds and no-load funds. Confusingly, an open-end fund may be described as "closed" but don't mistake that for closed-end. A closed-end fund looks much like a stock of a publically traded company: it's traded on some stock exchange, you buy or sell shares in the fund through a broker just like a stock (including paying a commission), the price fluctuates in response to the fund's performance and (very important) what people are willing to pay for it. Also like a publicly traded company, only a fixed number of shares are available. An open-end fund is the most common variety of mutual fund. Both existing and new investors may add any amount of money they want to the fund. In other words, there is no limit to the number of shares in the fund. Investors buy and sell shares usually by dealing directly with the fund company, not with any exchange. The price fluctuates in response to the value of the investments made by the fund, but the fund company values the shares on its own; investor sentiment about the fund is not considered. An open-end fund may be a load fund or no-load fund. An open-end fund that charges a fee to purchase shares in the fund is called a load fund. The fee is called a sales load, hence the name. The sales load may be as low as 1% of the amount you're investing, or as high as 9%. An open-end fund that charges no fee to purchase shares in the fund is called a no-load fund. Which is better? The debate of load versus no-load has consumed ridiculous amounts of paper (not to mention net bandwidth), and is debatable. Look, the fund is going to charge you something to manage your money, so you should consider the sales load in the context of all fees charged by a fund over the long run, then make up your own mind. In general you will want to minimize your total expenses, because expenses will diminish any returns that the fund achieves. One wrinkle you may encounter is a "closed" open-end fund. An open-end fund (may be a load or a no-load fund, doesn't matter) may be referred to as "closed." This means that the investment company decided at some point in time to accept no new investors to that fund. However, all investors who owned shares before that point in time are permitted to add to their investments. (In a nutshell: if you were in before, you can get in deeper, but if you missed the cutoff date, it's too late.) While looking at various funds, you may encounter a statistic labeled the "turnover ratio." This is quite simply the percentage of the portfolio that is sold out completely and issues of new securities bought versus what is still held. In other words, what level of trading activity is initiated by the manager of the fund. This can affect the capital gains as well as the actual expenses the fund will incur. Issues to look at when purchasing a Mutual Fund. Taxes,
taxes, taxes
One huge problem and perhaps the biggest drawback to investing in a mutual fund are the tax liabilities you will have at the end of the year. If your mutual fund manager sold stocks due to shareholder redemption or simply sold stocks because they feel that a particular stock within the mutual fund's portfolio has reached its full potential return, your fund experiences a capital gain. This capital gain is passed onto you and you must claim it as such on your tax return; even if you haven't sold any shares. Note:
This only applies to taxable accounts. If you are a mutual fund investor and it is held in a non taxable account such as a 401k or IRA, the above does not apply as you are not taxed until you withdraw your money out of your retirement funds. The
big killer for many investors is that the fund manager
takes actions that are right for the fund and those
actions may not be what is best for your individual
situation.
In
some cases by the time you look at per annual return
you end up much lower than expected.
Examples:
You receive a 6% return per annual minus fees at a rate of 2-3 % your actual growth would be 3-4% ( ? ). Now
what happens in a negative Year, lets look at a 3%
return at per annual and with fees at 4% your actual
return was a
( - ) 1% or negative 1%. If
your not careful the only one making money is the
Brokerage Company that has your money under
management, and in many cases is only concerned with
multiple under management accounts so they create
income from the fees.
Now Mutual's are great if they serve your
need and are applicable with combining into your
portfolio as a percentage of your portfolio and if you
are aware of all the details.
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