16 INVESTING IN MUTUAL FUNDS CHAPTER OVERVIEW This chapter describes mutual funds as an investment alternative. We begin our discussion by considering why investors purchase mutual funds. Then, we examine the characteristics of closed-end, exchange-traded, and open-end mutual funds. The differences between load funds and no-load funds are explained. We also explore the different fees associated with fund investments. We describe the major categories of mutual funds in terms of the types of securities they invest in. Finally, methods that can be used to evaluate mutual fund investments and the mechanics of buying and selling mutual fund transactions are presented. LEARNING OBJECTIVES CHAPTER SUMMARY After studying this chapter, students will be able to: LO 16-1 Describe the characteristics of mutual fund investments. The major reasons why investors choose mutual funds are profes- sional management and diversification. Mutual funds are also a convenient way to invest money. There are three types of mutual funds. A closed-end fund is a mutual fund whose shares are issued only when the fund is organized. An exchange-traded fund (ETF) is a fund that invests in the stock and securities contained in a specific stock or securities index. Both closed-end funds and exchange-traded funds are traded on a securities exchange or in the over-the-counter market. An open-end fund is a mutual fund whose shares are sold and redeemed by the investment company at the net asset value (NAV) at the request of investors. Mutual funds are also classified as load and no-load funds. A load fund charges a commission every time an investor purchases shares. No commission is charged to purchase shares in a no-load fund. Mutual funds can also be classified as “A” shares (commission charged when shares are purchased), “B” shares (commissions charged when money is withdrawn during the first five to seven years, and “C” shares (no commission to buy or sell shares, but higher, ongoing 12b-1 fees). Other possible fees include management fees, contingent deferred sales fees, and 12b-1 fees. Together all the different fees are reported as an expense ratio. 16-1 LEARNING OBJECTIVES CHAPTER SUMMARY LO 16-2 Classify mutual funds by investment objective. The major categories of stock mutual funds, in terms of the types of securities in which they invest, are aggressive growth, equity income, global, growth, index, international, large-cap, mid cap, regional, sector, small cap, and socially responsible. There are also bond funds that include high-yield, intermediate corporate, intermediate U.S. government, long-term corporate, long-term U.S. government, municipal, short-term corporate, short-term U.S. government and world. Finally, other funds invest in a mix of different stocks, bonds, and other investment securities that include asset allocation funds, balanced funds, fund of funds, lifecycle, and money-market funds. Today, many investment companies use a family of funds concept, which allows shareholders to switch their investments among funds as different funds offer more potential, financial reward, or security. LO 16- 3 Evaluate mutual funds for investment purposes. The responsibility for choosing the “right” mutual fund rests with you—the investor. One of the first questions you must answer is if you want a managed fund or an index fund. Most mutual funds are managed funds with a professional fund manager (or team of managers) who chooses the securities that are contained in the fund. An index fund invests in the securities that are contained in an index like the Standard & Poor’s 500 stock index. Statistically, the majority of managed mutual funds have failed to outperform the Standard & Poor’s 500 stock index over a long period of time. The information on the Internet, from professional advisory services, in the prospectus and annual reports, and in newspapers and financial publications can all help you evaluate a mutual fund. LO 16-4 Describe how and why mutual funds are bought and sold. The advantages and disadvantages of mutual funds have made mutual funds the investment of choice for many investors. For $250 to $3,000 or more, you can open an account and begin investing. The shares of a closed-end fund or exchange-traded fund are bought and sold on organized exchanges or the over-the- counter market. The shares of an open-end fund may be purchased through an account executive or salesperson who is authorized to sell them, from a mutual fund supermarket, or from the investment company that sponsors the fund. The shares in an open-end fund can be sold to the investment company that sponsors the fund. Shareholders in mutual funds can receive a return in one of three ways: income dividends, capital gain distributions when the fund buys and sells securities in the fund’s portfolio at a profit, and capital gains when the shareholder sells shares in the mutual fund at a higher price than the price paid. Unless your mutual fund account is part of an individual retirement account or 401k or 16-2 403(b) retirement account, income dividends, capital gain distributions, and capital gains are subject to taxation. A number of purchase and withdrawal options are available. INTRODUCTORY ACTIVITIES • Ask students to comment on the My Life feature: “Why Mutual Funds” for this chapter (p. 555). • Point out the learning objectives (p. 555) in an effort to highlight the key points in the chapter. • Ask students to express opinions they may have about investing in mutual funds. • Discuss how different investment objectives can be achieved with various types of mutual funds. • Ask if investors need to evaluate mutual funds since they are professionally managed. WHAT’S NEW Selected Topics Benefits for the Teaching and Learning Environment New Example: Janus Enterprise fund Updated Content: Fund statistics Expanded Coverage: Fund history Updated Did You Know New Exhibit 16-1: Fund diversification New information: Number of funds Updated Exhibit 16-2: Fund fee table New Example: A fund objective New box feature: Time value of money New Did You Know Illustrates how one person made money by investing in the Janus Enterprise fund. Provides new statistics about the people who invest in mutual funds. Adds new material about the history of mutual fund investing Includes current information about the age of investors who own mutual funds. Shows the type of stocks and securities included in the Invesco Growth and Income fund. Provides current numbers for exchange-traded, closed-end, and open-end funds. Illustrates the fee table for the Davis New York Venture fund. Provides the fund objective for the Vanguard Growth Equity fund. Ties the time value of money to fund investing. Illustrates the reasons why people invest in funds. 16-3 Expanded coverage: Fund managers New Did You Know Updated Exhibit 16-4: Large funds Expanded coverage: Professional advisory services New Exhibit 16-6: Information from Money Magazine Updated Example: Fidelity Stock Selector fund New Example: Withdrawals New Dashboard feature New Financial Planning Case Adds material about the role of a fund manager during both good and bad economic times. Provides information about the Morningstar “Star” ratings system. Updates information about three large funds: The Vanguard Group, Fidelity Investments, and American Funds. Provides more information and an example of the type of research information about funds that is available on the Morningstar website. Shows a portion of the “Money 70 Best Mutual Funds and ETFs” article from Money Magazine. Provides current price information used to illustrate a capital gain for the Fidelity Stock Selector fund. Adds an example of a withdrawal when an investor receives a portion of asset growth during an investment period. Points out that even with the professional management and diversification that funds offer, investors must still evaluate fund investments. Asks students to conduct research about a fund and then decide if they would invest money in the fund they chose. I. Why Investors Purchase Mutual Funds A. The Psychology of Investing in Funds B. Characteristics of Mutual Funds 1. Closed-End Funds 2. Exchange-Traded Funds 3. Open-End Funds 4. Load Funds and No-Load Funds 5. Management Fees and Other Charges II. Classifications of Mutual Funds A. Stock Funds B. Bond Funds 16-4 C. Other Funds III. How to Decide to Buy or Sell Mutual Funds A. Managed Funds Versus Indexed Funds B. The Internet C. Professional Advisory Services D. Mutual Fund Prospectus and Annual Reports E. Newspapers and Financial Publications IV. The Mechanics of a Mutual Fund Transaction A. Return on Investment B. Taxes and Mutual Funds C. Purchase Options D. Withdrawal Options 16-5 CHAPTER 16 LECTURE OUTLINE Instructional Suggestions • According to the Mutual Fund Education Alliance (http://www.mfea.com) a mutual fund pools the money of many investors—its shareholders—to invest in a variety of securities. • Mutual funds are an excellent choice for many individuals. • In many cases, they can also be used for retirement accounts, including traditional individual retirement accounts, Roth IRAs, employer-sponsored 401(k) and 403(b) retirement accounts. • When part of a retirement account at work, many employers will match the employee’s contribution. • Be warned: Although some employers reduced or eliminated matching provisions during the recent economic crisis, some employers still match employee contributions. • A common match might work like this: For every $1.00 the employee invests, the employer contributes an additional $0.25. • All monies—both the employee’s and employer’s contributions –are often invested in mutual funds that are selected by the employee. I. WHY INVESTORS PURCHASE MUTUAL FUNDS (p. 556) • The following statistics illustrate how important mutual funds investments are to both individuals and the nation’s economy. 1. An estimated 90.4 million individuals in nearly forty-five percent of all U.S. households own mutual funds. 2. The number of mutual funds grew from 361 in 1970 to almost 13,000 in late 2011, and continues to increase each year. 3. At the end of 2011, the last year for which complete totals are available, the combined value of assets owned by mutual funds in the United States totaled just over $13 trillion. This amount is expected to continue to increase based on long- term performance. • The major reasons why investors purchase mutual funds are professional management and diversification, or investment in a wide variety of • Use PPT slides 16-1 and 16.2. • Discussion Question: Why would an investor choose mutual funds for investment purposes? • Current Example: Professional fund managers base their investment decisions on market and economic conditions, interest rates, inflation, individual companies, business periodicals, government reports, and conversations with business executives. • Use PPT slide 16-3. • The Did You Know feature on page 557 provides current information about who owns mutual funds. • Use PPT slides 16-4 and 16.5. 16-6 CHAPTER 16 LECTURE OUTLINE Instructional Suggestions securities. • But be warned—even the best portfolio managers make mistakes. As an investor, you have to evaluate an investment in mutual funds just as you would evaluate any other potential investment. • The diversification of mutual funds spells safety, because an occasional loss incurred with one investment contained in a mutual fund is usually offset by gains from other investments in the fund. Characteristics of Mutual Funds (p. 557) • There are three ways to invest in the mutual funds offered by investment companies. 1. Closed-End Funds. Approximately 2 percent or about 240 of all mutual funds are closed-end funds offered by investment companies. A closed- end fund is a mutual fund whose shares are issued by an investment company only when the fund is organized. These funds are actively managed and shares of closed-end funds are traded on the floor of stock exchanges or in the over-the-counter market. Prices are determined by the factors of supply and demand, by the value of stocks and other investments contained in the fund’s portfolio, and by investor expectations. . 2. Exchange-Traded Funds. An exchange-traded fund (ETF) is a fund that generally invests in the stocks or other securities contained in a specific stock or securities index, like the Standard & Poor’s 500 stock index, the Dow Jones Industrial Average, or the Nasdaq 100 Index, and whose shares are traded on a securities exchange or over- the-counter market. Although exchanged-traded funds are similar to closed-end funds, there is an important difference. Most closed-end funds are actively managed, while most exchange-traded fund managers are passive and normally invest in the stocks included in a specific stock index. Note: There are a few actively managed ETFs. 3. With ETFs, shares can be bought and sold though a broker or online during regular market hours at the current price, and there is no minimum investment amount. Finally you can use limit orders and more speculative techniques. 4. The major disadvantage of exchange-traded funds is the cost of buying and selling shares. 5. While increasing in popularity, there are only about 1,000 exchange-traded funds, or about 8 • Text Highlight: Exhibit 16-1 provides information about the investment holdings in the Invesco Growth and Income Fund—see page 558. • Use PPT slide 16-6. • Use PPT slide 16-7. 16-7 CHAPTER 16 LECTURE OUTLINE Instructional Suggestions percent of all funds. 6. Open-End Funds. Approximately 90 percent— over 11,600 funds-- are classified as open-end funds. An open-end fund is a mutual fund whose shares are issued and redeemed by the investment company at the request of investors. • Use PPT slide 16-8. • Discussion Question: What is the difference between a closed- end fund, an exchange-traded fund, and an open-end fund? • Investors are free to buy and sell shares in an open- end fund at the net asset value. The net asset value (NAV) per share is equal to the current market value of the mutual fund’s portfolio minus the mutual fund’s liabilities divided by the number of shares outstanding. • For most mutual funds, the net asset value is calculated at the close of trading each day and investors’ requests to buy or sell shares are filled at the end of the trading day. • Load Funds and No-Load Funds. The investor should compare the cost of investing in a mutual fund with the cost of other investment alternatives. • Use PPT slide 16-9. • Text Highlight: You may want to review the net asset value calculation in the example on page 559. • The How To . . . Open an Investment Account and Begin Investing in Funds feature on page 560 provides 7 specific steps to help your students begin investing in funds. • With regard to cost, mutual funds are classified as 1. Load funds. 2. No-load funds. • The commission charge for load funds may be as high as 8 ½ percent of the purchase price. • While many exceptions exist, the average load charge for mutual funds is between 3 and 5 percent. • No-load funds don’t charge commissions when you buy shares because they have no salespeople. The chief reason why no-load funds may be a better choice is because you don’t pay sales fees and commissions to salespeople in order to purchase no- load funds. • Since no-load funds offer the same investment opportunities that load funds offer, you should investigate them further before deciding which type of mutual fund is best for you. • Some mutual funds charge a contingent deferred sales load of 1 to 5 percent that shareholders pay when they withdraw their investment from a mutual fund. These fees depend on how long the investor owns the fund. Generally, the deferred charge declines until there is no withdrawal charge if you own the shares in the fund for more than 5 to 7 years. • Management Fees and Other Charges. Mutual funds charge a management fee that ranges from 0.25 to 1.5 percent per year. While management fees vary, • Use PPT slide 16-10. • Discussion Question: What is the difference between a load and no-load mutual fund? • Text Highlight: You may want to discuss the example for a sales load calculation at this point in your lecture—see page 561. • Use PPT slide 16-11. • Text Highlight: You may want to discuss the example for calculating the contingent deferred sales load on page 562. • Use PPT slide 16-12. 16-8 CHAPTER 16 LECTURE OUTLINE Instructional Suggestions the average is 0.50 percent to 1 percent of the fund’s assets. • The investment company may also levy a 12b-1 fee to defray the costs of distribution and marketing a mutual fund. This annual fee cannot exceed 1 percent of a fund’s assets per year. Note: For a fund to be called -a “no-load” fund, its 12b-1 fee must not exceed 0.25 percent of its assets. • When compared to Class A shares (commissions charged when shares are purchased) and Class B shares (commissions charged when withdrawals are made over the first five to seven years), Class C shares, with their ongoing, higher 12b-1 fees, may be more expensive than Class A shares over a long period of time. • Together, all the different management fees, 12b-1 fees, if any, and additional fund operating costs for a specific fund are referred to as an expense ratio. • Financial planners recommend that you choose a mutual fund with an expense ratio of 1 percent or less. • Text Highlight: Use the My Life feature to review why investors choose fund investments--see p. 563. • Text Highlight: A fee table for the Davis New York Venture Mutual Fund is illustrated in Exhibit 16-2—see page 564. • Text Highlight: Exhibit 16-3 illustrates typical fees associated with mutual funds—see page 564. • Use Transparency Master 16- 1. • Use PPT slide 16-13 and 16-4. • Practice Quiz 16-1 (p. 563) II. CLASSIFICATIONS OF MUTUAL FUNDS (p. 565) • The managers of mutual funds tailor their investment portfolios in order to achieve specific investment objectives. • The major categories of mutual funds, in terms of the types of securities they invest in, are as follows: • Text Highlight: You may want to discuss the objectives of the Vanguard Growth Equity fund described in this section on page 565. Stock Funds (p. 565) 1. Aggressive growth funds 2. Equity income funds 3. Global stock funds 4. Growth funds 5. Index funds 6. International funds 7. Large-cap funds 8. Mid-cap funds 9. Regional funds 10. Sector funds 11. Small-cap funds 12. Socially-responsible funds Bond Funds (p. 567) 1. High-yield (junk) bond funds 2. Intermediate corporate bond funds 3. Intermediate U.S. bond funds 4. Long-term corporate bond funds • Use PPT slides 16-15 through 16-22. • Text Highlight: You may want to discuss the material on the time value of money in the Financial Planning for Life's Situations feature on page 565. • Text Highlight: To reinforce the importance of matching your investment objective with a specific fund’s objective, you may want students to review the My Life feature on page 566. • The Did You Know feature provides information about the why people invest in funds--see page 566. 16-9 CHAPTER 16 LECTURE OUTLINE Instructional Suggestions 5. Long-term U.S bond funds 6. Municipal bond funds 7. Short-term corporate bond funds 8. Short-term (U.S.) government bond funds 9. World bond funds Other Funds (p. 567) 1. Asset allocation funds 2. Balanced funds 3. Fund of funds 4. Lifecycle funds 5. Money-market funds • Discussion Question: Which type of mutual fund could help you obtain your financial goals? Why? • A family of funds exists when one investment company manages a group of mutual funds. Most investment companies offer exchange privileges that enable shareholders to readily switch among the mutual funds in a fund family. • Use PPT slide 16-23. • Practice Quiz 16-2 (p. 568) III. HOW TO DECIDE TO BUY OR SELL MUTUAL FUNDS (p. 568) • The responsibility for choosing the right mutual funds rests with you the investor. After all, you are the only one who knows how a particular mutual fund can help you achieve your financial objectives. Managed Funds Versus Indexed Funds (p. 568) • Most mutual funds are managed funds. In other words, there is a professional fund manager (or team of managers) that chooses the securities that are contained in the fund. • Instead of investing in a managed fund, some investors choose to invest in an index fund. Why? The answer to that question is simple: Over many years, the majority of managed mutual funds fail to outperform the Standard & Poor’s 500 stock index. The exact statistics vary depending on the year and the specific fund, but on average the Standard & Poor 500 stock index outperforms 50 to 80 percent of actively managed funds over a long period of time. • The major reason why index funds outperform managed funds is because index funds have lower annual fees when compared to managed funds. • Also, it’s hard to beat an index like the Standard & Poor’s 500. • If the individual securities included in an index increase, the index goes up. Because an index mutual fund is a mirror image of a specific index, the dollar value of a share in an index fund also increases when • Use PPT slides 16-24 and 16- 25. • Discussion Question: What is the difference between a managed fund and an index fund? Which fund would you choose to help you obtain your investment goals? 16-10 CHAPTER 16 LECTURE OUTLINE Instructional Suggestions the index increases. • Unfortunately, the reverse is true. • The concept behind index funds is based on the efficient market hypothesis discussed in Chapter 14. • Index funds, sometimes called “passive” funds, have managers, but they simply buy the stocks or bonds contained in the index. • As mentioned earlier, a very important reason why investors choose index funds is the lower expense ratio charged by index funds. Typical expense ratios for an index fund are 0.50 percent or less. Remember: financial planners recommend that you choose a fund with an expense ratio of 1 percent or less. The Internet (p. 569) • It is possible to use the Internet to obtain information about mutual funds. Not only is it possible to obtain current market values, you can also access home pages of the investment company sponsoring the mutual fund and different professional advisory services. Professional Advisory Services (p. 570) • A number of subscription services provide detailed information on mutual funds. Standard and Poor’s Corporation, Lipper Analytical Services, Morningstar, Inc., and Value Line are widely used sources of information. In addition, various mutual fund newsletters provide financial information to subscribers for a fee. • The Did You Know feature provides information about Morningstar's "Star" ratings— see page 569. • Text Highlight: Information about the 3 of the largest investment companies is provided in Exhibit 16-4—see page 570. • Use PPT slide 16-26. • Text Highlight: The My Life feature stresses the importance of obtaining research information from professional advisory services (page 571). • Use PPT slide 16-27. • Text Highlight: Information about the Vanguard 500 Index Investor Fund available from the Morningstar Web site is provided in Exhibit 16-5—see page 572. Mutual Fund Prospectus and Annual Reports (p. 573) • An investment company sponsoring a mutual fund must give potential investors a prospectus. • The prospectus should provide the answers to a number of questions—see text page 573. • Once you are a shareholder, the investment company will send you annual reports which can provide useful information for evaluation purposes. Newspapers and Financial Publications (p. 573) • Although many newspapers have reduced or eliminated mutual fund coverage, many large metropolitan newspapers and The Wall Street Journal often provide news and information about mutual fund investments. • Use PPT slide 16-28. • Discussion Question: What type of information do a fund prospectus and a fund annual report provide? • Use PPT slide 16-29. • Use Transparency Master 16- 2. • Text Highlight: You may want to discuss Exhibit 16-6 on page 574—Money Magazine’s 2013 list of high quality funds and ETFs—at this point in your lecture. 16-11 CHAPTER 16 LECTURE OUTLINE Instructional Suggestions • Typical coverage includes the name of a fund family, and names of specific funds within the family, current net asset value for a fund, and percentage of year-to- date (YTD) return. • Another source of information about mutual funds is investment-oriented magazines like Bloomberg Businessweek, Forbes, Fortune, Kiplinger’s Personal Finance Magazine, and Money. • A number of mutual fund guidebooks are available at your local bookstore or public library. • Practice Quiz 16-3 (p. 574) IV. THE MECHANICS OF A MUTUAL FUND TRANSACTION (p. 575) • In this section, we discuss four important topics. 1. We examine how shareholders can make money by investing in closed-end, exchange-traded, or open-end mutual funds. 2. We consider how taxes affect your fund investments. 3. We look at the options that can be used to purchase shares in a mutual fund. 4. We look at the options that can be used to withdraw money from a mutual fund. Return on Investment (p. 575) • As with other investments, the purpose of investing in a closed-end, exchange-traded, or an open-end fund is to earn a financial return. • Shareholders in such funds can receive a return in one of three ways. 1. All three types of funds pay income dividends. Income dividends are the earnings that a fund pays to shareholders from its dividend and interest income. 2. Mutual funds also pay capital gain distributions. Capital gain distributions are the payments made to a fund’s shareholders that result from the sale of securities in the fund’s portfolio. Note: the majority of exchange-traded funds don’t usually pay end-of-the-year capital gain distributions. 3. As with stock investments, it is possible to buy shares in funds at a low price and then to sell them after the price has increased. The profit that results from an increase in value is referred to as a capital gain. Of course, if the price of a fund’s shares goes down, the shareholder incurs a loss. 4. Note the difference between a capital gain distribution and a capital gain. • Discussion Question: How can an investor make money with a mutual fund investment? • Use PPT slide 16-30. • Text Highlight: The advantages and disadvantages of investing in mutual funds are presented in Exhibit 16-7—see page 575. • Use Transparency Master 16- 3. • Use PPT slides 16-31 and 16- 32. • The Did You Know feature provides information about a common mistake made by fund investors—see page 576. • Text Highlight: The My Life feature reviews how investors make money with fund investments (page 576). • Text Highlight: You may want to discuss the material on calculating total return and percent of total return for mutual funds presented in the “Financial Planning Calculations” boxed feature. (p. 577) 16-12 CHAPTER 16 LECTURE OUTLINE Instructional Suggestions Taxes and Mutual Funds (p. 576) Income dividends, capital gains distributions, and financial gains and losses from the transactions of closed- end, exchange-traded, or open-end funds are subject to taxation. • When you pay taxes depends on the type of account you own. For example, taxes can be postponed until you begin making withdrawals if the shares are part of a 401(k) retirement account or individual retirement account. • On the other hand, if your shares are part of a taxable account, you pay taxes each year. • For taxable accounts, investment companies are required to send each shareholder a statement specifying how much he or she received in dividends and capital gain distributions at the end of each year. • Although investment companies may provide this information as part of their year-end statement, most funds also use IRS Form 1099 DIV. • Reminder: Be sure you understand the difference between capital gains distributions and capital gains. • Caution: Even if you reinvest income dividends and capital gain distributions in a taxable account, they are still taxable and must be reported on your federal tax return. • Because income dividends and capital gain distributions are taxable, one factor to consider when choosing a mutual fund is its turnover. For a mutual fund, the turnover ratio measures the percentage of a fund’s holdings that have been changed or “been replaced” during a 12-month period of time. • Caution: Unless you are using the fund in a retirement account, a fund with a high turnover ratio can result in higher income tax bills and higher transaction costs. • Be sure to keep accurate records for tax purposes. • Use PPT slide 16-33. Purchase Options (p. 578) • The shares of a closed-end or exchange-traded funds are traded on various securities exchanges or in the over-the-counter market. • The shares of an open-end fund may be purchased through an account executive or salesperson who is authorized to sell them, or directly from the investment company that sponsors the fund. • You can also purchase shares from a mutual fund supermarket. • Use PPT slide 16-34. 16-13 CHAPTER 16 LECTURE OUTLINE Instructional Suggestions • All four purchase options (regular accounts, voluntary savings plans, contractual savings plans, and reinvestment plans) allow investors to buy shares over a long period of time. As a result, they can use the principle of dollar cost averaging. Withdrawal Options (p. 579) • Because closed-end and exchange-traded funds are listed on securities exchanges or traded in the over-the- counter market, it is possible to sell shares in such a fund to another investor. • Discussion Question: Which purchase option would you choose to purchases shares in an open-end fund? • Caution: Many investors and government regulatory agencies are critical of contractual savings plans because of penalties that the fund imposes on investors who do not fulfill the contractual requirements. • Shares in an open-end fund can be sold on any business day to the investment company that sponsors the fund. In this case, shares are redeemed at their net asset value. • In addition to just selling shares, the investor may use at least four options to systematically withdraw money from an open-end mutual fund. 1. Most funds have a provision that allows investors to systematically withdraw a specified, fixed dollar amount of money each investment period. 2. A second option allows the investor to liquidate or “sell off” a certain number of shares each investment period. 3. A third option allows investors to withdraw a fixed percentage of asset growth. • Discussion Question: What methods can be used to withdraw money from an open- end fund? 4. A final option allows the investor to withdraw all asset growth that results from income, dividends, and capital gains earned by the fund during an investment period. • Practice Quiz 16-4 (p. 580) CONCLUDING ACTIVITIES • Point out the Dashboard and My Life Stages for Investing in Mutual Fund features, chapter summary, and key terms (pp. 580). • Discuss selected end-of-chapter key formulas, self-test problems, financial planning problems, financial planning activities, financial planning case, and continuing case. • Use the Chapter Quiz in this Instructor's Manual and/or activities on the student website. 16-14 WORKSHEETS FROM PERSONAL FINANCIAL PLANNER FOR USE WITH CHAPTER 16 Sheet 61 Mutual Fund Investment Information Sheet 62 Mutual Fund Evaluation CHAPTER 16 QUIZ ANSWERS True-False Multiple Choice 1. T (p. 557) 6. B (p. 559) 2. T (p. 557) 7. D (p. 562) 3. F (p. 562) 8. D (p. 567) 4. T (p. 567) 9. D (p. 573) 5. T (p. 578) 10. B (p. 576) 16-15 Name ________________________________________ Date____________________________ CHAPTER 16 QUIZ TRUE-FALSE _____1. The major reasons why investors purchase mutual funds are professional management and diversification. _____2. Shares in a closed-end mutual fund are issued by the investment company only when the fund is organized. _____3. Typically, the management fee for a mutual fund ranges between 3 and 5 percent of the total dollar amount invested. _____4. A family of funds exists when one investment company manages a group of mutual funds. _____5. Generally, there are a number of purchase options and withdrawal options for investors that purchase mutual funds. MULTIPLE CHOICE _____6. A mutual fund in which new shares are issued and redeemed by the investment company at the request of investors is called a(n) ____________ fund. a. closed end b. open-end c. load d. no-load _____7. Some mutual funds charge 12b-1 fees to defray the cost of a. management of the fund. b. recordkeeping for securities in the fund’s portfolio. c. withdrawal options of the mutual fund. d. distribution and marketing the mutual fund. _____8. An investor who wants a tax-free investment would choose a(n) ____________ fund. a. balanced b. income c. sector d. municipal bond _____9. A document that prospective mutual fund investors receive is called a(n) a. SEC report. b. load fund report. c. index fund report. d. prospectus. _____10. Payments made to a fund’s shareholders that result from the sales of securities in the fund’s portfolio are called a. income dividends. b. capital gain distributions. c. tax-free income. d. none of the above. 16-16 SUPPLEMENTARY LECTURE This lecture should help students understand the importance of reading the fine print in a contractual savings plan agreement that may be used in connection with mutual fund investments. Introduction On June 14, 2010, Mike Dobson signed an agreement to buy shares in XYZ mutual fund. As part of the contract, Mike agreed to make monthly purchases in the amount of $200 for the next 10 years. The sales representative for XYZ told Mike that the company insisted on the contractual savings plan arrangement because it helped individual investors “discipline” themselves to make regular purchases. The Problem After three years, Mike got tired of making $200 monthly installments. Besides, his total three-year investment in the mutual fund—over $7,000—had a current market value of less than the total of his contributions. He contacted the salesperson who had signed him up and told him that he wanted to withdraw his money. The salesperson told him that he could “cash in” his investment, but that a large portion of his monthly investments had gone to pay the up-front commissions. If he were to cash in his investment now, he would receive only about $4,000. Finally, the salesperson told him that he should stick it out and continue to make monthly purchases. At this point, you may want to ask students the following questions. 1. What would you do if you were Mike Dobson? 2. Does it seem fair that most of the commissions are charged in the first three years? Final Note Many financial planners and government regulatory agencies are critical of contractual savings plans. As a result, the Securities and Exchange Commission and many states have imposed new disclosure rules on investment companies offering contractual savings plans. 16-17 ANSWERS TO PRACTICE QUIZ QUESTIONS, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, FINANCIAL PLANNING CASE, AND CONTINUING CASE PRACTICE QUIZZES Practice Quiz 16-1 (p. 563) 1. What are two major reasons why investors purchase mutual funds? The major reasons why investors purchase mutual funds are professional management and diversification. (p. 557) 2. How do a closed-end fund, an open-end fund, and an exchange-trade fund differ? A closed-end fund is a mutual fund whose shares are issued by an investment company only when the fund is organized. After all the shares originally issued have been sold, an investor can purchase shares only from another investor who is willing to sell them. An exchange-traded fund (ETF) is a fund that invests in the stocks contained in a specific stock or securities index. Although most closed- end funds are actively managed, ETF managers are more passive. Shares for both closed-end and exchange-trade funds are traded on organized exchanges or in the over-the-counter market. An open- end fund is a mutual fund whose shares are issued and redeemed by the investment company at the request of investors. Investors are free to buy and sell shares at the net asset value. (pp. 557-561) 3. What are the typical sales fees charged for a load and no-load mutual fund? Fees for a load fund may be as high as 8 ½ percent. While many exceptions exist, the average load charge for mutual funds is between 3 and 5 percent. A no-load fund is a mutual fund in which no sales charge is paid by the individual investor. (p. 561) 4. What is the difference among Class A, B, and C shares? With Class A shares, investors pay a commission when they purchase shares. With Class B shares, investors pay a commission when they sell shares during the first five to seven years. With Class C shares, investors pay no commission to buy or sell shares, but pay higher ongoing 12b-1 fees when compared to Class A shares over a long period of time. (p. 563) 5. What are the typical management fees, 12b-1 fees, and expense ratios? While fees vary considerably, the typical annual management fee for a mutual fund is calculated on the value of a fund’s total assets and ranges between 0.50 and 1 percent per year. A 12b-1 fee is used to defer the costs of distribution and marketing a mutual fund. Typical annual 12b-1 fees cannot exceed 1 percent of the fund’s assets. Together, all the different management fees, 12b-1 fees, if any, and any additional fund operating costs are referred to as an expense ratio. As a guideline, many financial experts recommend that you choose a fund with an expense ratio of 1 percent or less. (pp. 562-563) Practice Quiz 16-2 (p. 568) 1. How important is the investment objective as stated in the fund’s prospectus? The managers of mutual funds tailor their investment portfolios to the investment objectives of their customers. As such, investors must make sure that their objectives and a prospective mutual fund’s objectives match. (p. 565) 16-18 2. Why do you think fund managers offer so many different kinds of funds? Fund managers know that investors have different objectives, and therefore, offer funds to match those objectives. (p. 565) 3. What is a family of funds? How is it related to shareholder exchanges? A family of funds exists when one investment company manages a group of mutual funds. Each fund within the family has a different financial objective. Generally, investors may give instructions to switch from one fund to another within the same family. (p. 567) Practice Quiz 16-3 (p. 574) 1. Many financial experts say that purchasing a mutual fund is “too easy.” Do you think this statement is true or false? Explain. Certainly, investment companies do make it easy for investors to purchase shares in a mutual fund. Yet, it is still the investor’s money, and there is no substitute for conducting research when purchasing shares in a mutual fund. Simply put: the best investors are the ones who research their investments. (p. 568) 2. In your own words, describe the difference between a managed fund and an index fund. Which fund would you choose for your investment program? Most mutual funds are managed funds. In other words, there is a professional fund manager (or team of managers) that chooses the securities that are contained in the fund. Instead of investing in a managed fund, some investors choose an index fund. Because an index mutual fund is a mirror image of a specific index, the dollar value of a share in an index fund also increases when the index increases. Unfortunately, the reverse is true. You may want to point out that over a long period of time the majority of mutual funds fail to outperform index funds. The exact statistics vary depending on the year and the specific fund, but on average the Standard & Poor 500 stock index beats the returns of 50 to 80 percent of actively managed funds over a long period of time. (pp. 568-569) 3. How can the following help you evaluate a mutual fund? a. The Internet b. Professional advisory services c. The prospectus d. The annual report e. Newspapers and financial publications The Internet can provide investors with current market values, information about the fund provided by the investment company sponsoring the fund, and by professional advisory services. Professional advisory services provide investors with the most detailed information about mutual funds. The prospectus contains a summary of the fund and information about fees, past financial performance, and the fund’s management. The annual report contains detailed financial information on the fund’s assets and liabilities, statement of operations, and statement of changes in net asset value. The annual report also contains a schedule of investments and a letter from the fund’s independent auditors. Newspapers provide current information about a mutual fund’s net asset value, change in net asset value, and year-to-date returns Financial publications provide investors with another detailed source of information about mutual funds. (pp. 569-574) 16-19 Practice Quiz 16-4 (p. 580) 1. How can an investor make money when investing in mutual funds? Closed-end funds, exchange-traded, and open-end funds pay both income dividends and capital gain distributions. Also, it is possible to buy shares in each type of fund at a low price and then to sell them after the price has increased. The profit that results from this type of transaction is referred to as a capital gain. (p. 575) 2. What are the differences among income dividends, capital gain distributions, and capital gains? Income dividends are the earnings a fund pays to shareholders from its dividend and interest income. Capital gain distributions are the payments made to a fund’s shareholders that result from the fund selling securities in the fund’s portfolio. A capital gain results when a shareholder decides to sell shares in a mutual fund at a price that is higher than the price paid for the shares. (pp. 576-578) 3. How would you purchase a closed-end fund? An exchange-traded fund? Shares of a closed-end and exchange-traded funds are traded through various other stock exchanges, or in the over-the-counter market. (p. 578) 4. What options can be used to purchase shares in an open-end mutual fund from an investment company? The shares of an open-end fund may be purchased through a salesperson who is authorized to sell them, through an account executive, through a mutual fund supermarket, or directly from the investment company. To purchase shares from an investment company, investors may also use these options: regular account transactions, voluntary savings plans, contractual savings plans, and reinvestment plans. (pp. 578-579) 5. What options can be used to withdraw money from an open-end mutual fund? Shares in an open-end fund can be sold on any business day to the investment company that sponsors the fund. Investors may also use these options to withdraw funds: (1) withdraw a specified, fixed dollar amount each investment period; (2) liquidate a certain number of shares each investment period; (3) withdraw a fixed percentage of asset growth; and (4) withdraw all asset growth that results from income and dividends and capital gain distributions earned by the fund during an investment period. (p. 579) FINANCIAL PLANNING PROBLEMS (p. 584) 1. Calculating Net Asset Value. Given the following information, calculate the net asset value for the Boston Equity mutual fund. Total assets $240,000,000 Total liabilities 8,000,000 Total number of shares 5,000,000 The net asset value per share is equal to the current market value of the mutual fund’s portfolio minus the mutual fund’s liabilities divided by the number of shares outstanding. For the above information, the net asset value is $46.40 as calculated below. Net asset value = 5,000,000 $240,000,000 $8,000,000 Net asset value = $46.40 per share 16-20 Learning Objective: 16-1 Topic: Why Investors Purchase Mutual Funds Level of Difficulty: Easy Bloom’s Tag: Application 2. Calculating Net Asset Value. Given the information below, calculate the net asset value for the New Empire small-cap mutual fund. Total assets $380,000,000 Total liabilities 15,000,000 Total number of shares 25,000,000 The net asset value per share is equal to the current market value of the mutual fund’s portfolio minus the mutual fund’s liabilities divided by the number of shares outstanding. For the above information, the net asset value is $14.60 as calculated below. Net asset value = 25,000,000 $380,000,000 $15,000,000 Net asset value = $14.60 per share Learning Objective: 16-1 Topic: Why Investors Purchase Mutual Funds Level of Difficulty: Easy Bloom’s Tag: Application 3. Calculating Sales Fees. Jan Throng invested $31,000 in the Invesco Charter Mutual Fund. This fund charges a 5.50 percent commission when shares are purchased. Calculate the amount of commission Jan must pay. Ms. Throng must pay $1,705 for commissions as illustrated below. Dollar amount of commission = Original investment x Commission stated as a percentage The commission is also referred to as the sales load. $1,705 = $31,000 0.055 Learning Objective: 16-1 Topic: Why Investors Purchase Mutual Funds Level of Difficulty: Medium Bloom’s Tag: Application 4. Calculating Sales Fees. Bill Matthews invested $9,500 in the John Hancock Government Income fund. The fund charges 4.5 percent commission when shares are purchased. Calculate the amount of commission Bill must pay. Mr. Matthews must pay $427.50 for commissions as illustrated below. Dollar amount of commission = Original investment x Commission stated as a percentage The commission is also referred to as the sales load. 16-21 $427.50 = $9,500 0.045 Learning Objective: 16-1 Topic: Why Investors Purchase Mutual Funds Level of Difficulty: Medium Bloom’s Tag: Application 5. Calculating Contingent Deferred Sales Loads. Ted Paulson needed money to pay for unexpected medical bills. To obtain $6,000, he decided to sale some of his shares in the Ridgemoor Capital Appreciation Fund. When he called the investment company, he was told that the following fees would be charged to sell his “B” shares: First year 5 percent withdrawal fee Second year 4 percent withdrawal fee Third year 3 percent withdrawal fee Fourth year 2 percent withdrawal fee Fifth year 1 percent withdrawal fee If he has owned the fund for 21 months and withdraws $6,000 to pay medical bills, what is the amount of the contingent deferred sales load? The contingent deferred sales load Mr. Paulson must pay is $240, as calculated below. Contingent deferred sales load = Withdrawal amount x Contingent deferred sales load as a percentage. $240 = $6,000 x 0.04 (second year withdrawal fee) Learning Objective: 16-1 Topic: Why Investors Purchase Mutual Funds Level of Difficulty: Medium Bloom’s Tag: Application, Analysis 6. Calculating Contingent Deferred Sales Loads. Mary Canfield purchased the New Dimensions bond fund. While this fund doesn’t charge a front-end load, it does charge a contingent deferred sales load of 4 percent for any withdrawals for the first five years. If Mary withdraws $7,500 during the second year, how much is the contingent deferred sales fee? Ms. Canfield must pay a $300 contingent deferred sales load, as illustrated below. Contingent deferred sales load = Withdrawal amount x Contingent deferred sales load as a percentage $300 = $7,500 0.04 (withdrawal fee) Learning Objective: 16-1 Topic: Why Investors Purchase Mutual Funds Level of Difficulty: Medium Bloom’s Tag: Application, Analysis 16-22 7. Determining Management Fees. Mike Jackson invested a total of $22,000 in the New Colony Pacific Region mutual fund. The management fee for this particular fund is 0.80 percent of the total asset value. Calculate the management fee that Mike must pay this year. Mr. Jackson must pay a $176.00 management fee. $22,000 total investment 0.0080 management fee percentage = $176.00 management fee Learning Objective: 16-1 Topic: Why Investors Purchase Mutual Funds Level of Difficulty: Medium Bloom’s Tag: Application 8. Calculating 12b-1 Fees. Jane Ramirez owns shares in the Touchstone Health and Biotechnology Fund that have a current value of $13,150. The fund charges an annual 12b-1 fee of 0.25 percent. What is the amount of the 12b-1 fee Ms. Ramirez must pay? The 12b-1 fee that Ms Ramirez must pay is $32.88, as calculated below. $32.88 = $13,150 x 0.0025 Learning Objective: 16-1 Topic: Why Investors Purchase Mutual Funds Level of Difficulty: Medium Bloom’s Tag: Application 9. Calculating Mutual Fund Fees. In the prospectus for the Brazos Small Cap Fund, the fee table indicates that the fund has a 12b -1 fee of 0.35 percent and an expense ratio of 1.65 percent that is collected once a year on December 1. If Joan and Don Norwood have shares valued at $31,000 on December 1: a. What is the amount of the 12b-1 fee this year? b. What is the amount they will pay for expenses this year? a. The 12b-1 fee is $108.50, as calculated below. $108.50 = $31,000 x 0.0035 b. Total expenses are $511.50, as calculated below. $511.50 = $31,000 x 0.0165 Learning Objective: 16-1 Topic: Why Investors Purchase Mutual Funds Level of Difficulty: Medium Bloom’s Tag: Application 16-23 10. Finding Total Return. Assume that one year ago you bought 100 shares of a mutual fund for $13.50 per share, you received $0.42 per share capital gain distribution during the past 12 months, and the market value of the fund is now $17. Calculate the total return for this investment if you were to sell it now. Dollar amount of total return = Capital gain distributions + Change in market value Total return is (1) Capital gain distributions = $0.42 100 shares = $42 (2) Change in market value = $1,700 sales price - $1,350 purchase price = $350 (3) Total dollar return = $42 + $350 = $392 Learning Objective: 16-4 Topic: The Mechanics of a Mutual Fund Transaction Level of Difficulty: Difficult Bloom’s Tag: Application; Analysis 11. Finding Percent of Total Return. Given the information in Question 10, calculate the percent of total return for your $1,350 investment. The percent of total return is 29.04 percent, as illustrated below. Percent of total return = Dollar amount of total return / Original costs of your investment $392 ÷ $1,350 = 0.2904 = 29.04 percent Learning Objective: 16-4 Topic: The Mechanics of a Mutual Fund Transaction Level of Difficulty: Medium Bloom’s Tag: Application 12. Finding Total Return. Assume that one year ago, you bought 200 shares of a mutual fund for $21 per share, you received an income distribution of $0.11 cents per share, and a capital gain distribution of $0.32 cents per share during the past 12 months. Also assume the market value of the fund is now $23 a share. Calculate the total return for this investment if you were to sell it now. Dollar amount of total return = Capital gain distributions + Change in market value Total Return is (1) Income and capital gains distributions = ($0.11 + $0.32) x 200 shares = $86 (2) Change in market value = $4,600 sales price – $4,200 purchase price = $400 (3) Total dollar return = $86 + $400 = $486 Learning Objective: 16-4 Topic: The Mechanics of a Mutual Fund Transaction Level of Difficulty: Difficult Bloom’s Tag: Application; Analysis 13. Finding Percent of Total Return. Given the information in question 12, calculate the percent of total return for your $4,200 investment. The percent of total return is 11.57 percent, as illustrated below. 16-24 Percent of total return = Dollar amount of total return / Original cost of your investment $486 ÷ $4,200 = 0.1157 = 11.57% Learning Objective: 16-4 Topic: The Mechanics of a Mutual Fund Transaction Level of Difficulty: Medium Bloom’s Tag: Application 14. Using Dollar-Cost Averaging. Over a four-year period, Matt Ewing purchased shares in the Oakmark I Fund. Using the following information, answer the questions below. You may want to review the concept of dollar cost averaging in Chapter 14 before completing this problem. Year Investment Amount Price per share 2010 $3,000 $40 per share 2011 $3,000 $45 per share 2012 $3,000 $42 per share 2013 $3,000 $50 per share a. At the end of four years, what is the total amount invested? b. At the end of four years, what is the total number of mutual fund shares purchased? c. At the end of four years, what is the average cost for each mutual fund share? a. At the end of four years, Mr. Ewing has invested a total of $12,000 ($3,000 x 4 years = $12,000). b. At the end of four years, Mr. Ewing owns 273.1 shares, as illustrated below. 2010 = $3,000 ÷ $40 = 75.0 shares 2011 = $3,000 ÷ $45 = 66.7 shares 2012 = $3,000 ÷ $42 = 71.4 shares 2013 = $3,000 ÷ $50 = 60.0 shares 273.1 shares c. At the end of four years, the average cost for each mutual fund share is $43.94, as illustrated below. $12,000 ÷ 273.1 shares = $43.94 Learning Objective: 16-4 Topic: The Mechanics of a Mutual Fund Transaction Level of Difficulty: Difficult Bloom’s Tag: Application 15. Calculating Withdrawal Amounts. Since Tanya Martin retired, she has used income from her investment in the Alger Mid Cap growth fund to supplement her other retirement income. During one three month period, the fund grew by $4,000. If she withdraws 65 percent of the growth, how much will she receive? If the value of this fund increased by $4,000, she will receive $2,600. 16-25 $4,000 fund growth x 0.65 = $2,600 Learning Objective: 16-4 Topic: The Mechanics of a Mutual Fund Transaction Level of Difficulty: Difficult Bloom’s Tag: Application FINANCIAL PLANNING ACTIVITIES (p. 586) 1. Deciding Whether Mutual Funds Are Right for You. Assume that you are 35, are divorced, and have just received a $120,000 legal settlement. Prepare a one-page report on the major reasons you want to invest in mutual funds. (LO16-1) The major reasons why investors purchase mutual funds are professional management and diversification. It is also easy to invest in mutual funds. A major disadvantage of a mutual fund investment is that fund managers do make mistakes. Therefore, it is the investors’ responsibility to evaluate any mutual fund investment. When responding to this question, students should take into consideration that this investor is 35 and divorced. These two factors may indicate that the investor should consider more conservative mutual funds. Still, someone who is 35 must be concerned with long-term growth in order to reach retirement goals. 2. Applying Terms to Mutual Fund Investments. Using the Internet, or recent newspapers, magazines, or mutual fund reports, find examples of the following concepts. (LO 16-1) a. The net asset value of a mutual fund b. An example of a load fund c. An example of a no-load fun d. The management fee for a specific mutual fund e. A fund that charges a contingent deferred sales load f. A fund that charges a 12b-I fee g. An expense ratio Student answers for this question will vary depending on the source of their information and the funds they choose. 3. Matching Mutual Funds with Investor Needs. This chapter classified mutual funds into different categories based on the nature of the fund’s investments. Using the following information, pick a mutual fund category that you consider suitable for each of the investors described and justify your choice. (LO 16-2) a. A 25-year-old investor with a new job that pays $30,000 a year. Mutual fund category ___________________________________________________________ Why _________________________________________________________________________ b. A single parent with two children who has just received a $300,000 divorce settlement, has no job, and has not worked outside the home for the past five years. Mutual fund category ____________________________________________________________ Why _________________________________________________________________________ 16-26 c. A husband and wife who are both in their early 60s and retired. Mutual fund category ___________________________________________________________ Why _________________________________________________________________________ a. Because this investor is young (25), has a job that pays $30,000 a year, and there is no mention of family responsibilities, a mutual fund that stresses growth potential is a good choice. Growth funds invest in the common stocks of well-managed, rapidly growing corporations with higher than average revenues and earnings growth. b. Because this investor is a single parent with two children, no job, and hasn’t worked outside of the home for the past five years, a mutual fund that stresses growth and income is a good choice. Growth funds invest in stocks that provide for increases in value while income funds invest in stocks that provide a predictable source of income. (Note: Because of this investor’s situation, safety and preservation of capital are additional concerns.) c. Because these investors are in their 60s and retired, a mutual fund that stresses both safety and income is a good choice. Mutual funds in this category include some balanced funds, some corporate bond funds, some growth and income funds, and municipal bond funds. Today, many financial experts would recommend that a small portion of this couple’s portfolio be invested in conservative growth funds. 4. Matching Mutual Funds with Investor Needs. This chapter explored a number of different classifications of mutual funds. (LO 16-2) a. Based on your age and current financial situation, which type of mutual fund seems appropriate for your investment needs? Explain your answer. b. As people get closer to retirement, their investment goals often change. Assume that you are now 45 and have accumulated $110,000 in a retirement account. In this situation, what type of mutual fund would you choose? Why? c. Assume that you are now 60 years of age and have accumulated $400,000 in a retirement account. Also, assume that you would like to retire when you are 65. What type of mutual funds would you choose to help obtain your investment goals? Why? a. Student answers will vary depending on their age and investment philosophy. For someone in their twenties, investments should provide the type of long-term growth possibilities that will enable them to grow their retirement nest egg over a long period of time. b. As people get older, they tend to choose more conservative investments. Since most people don’t retire until they are 60 to 65, you still have a number of years for your investments to appreciate. Perhaps conservative mutual funds that emphasize growth could be chosen. c. The fact that you are now 60 should be taken into consideration. More conservative mutual funds that emphasize preservation of capital and predictable sources of income are a wise choice for people who are near retirement age. While it is still desirable to have some growth component in their portfolio, investors tend to be concerned with safety. 5. Using the Internet to Obtain a Prospectus. Use the Internet to obtain a prospectus for a specific mutual fund that you believe would be a quality long-term investment. Then describe the purchase and withdrawal options described in the fund's prospectus. (LO 16-3) While student answers will vary depending on the fund they choose, you may want to use this question to stress the importance of evaluating any mutual fund investment. One place to obtain information about a specific mutual fund is the fund's prospectus, which will answer many of the 16-27 questions about a fund that are listed on page 573. Student answers should also describe the purchase and withdrawal options for their fund. 6. Using the Yahoo! Finance Website. Visit the Yahoo Finance website and evaluate one of the mutual funds listed below. To complete this activity, follow these steps. (LO 16-3) a. Go to http://finance.yahoo.com. b. Choose one of the three funds, enter its symbol, and click on the “Quote Lookup” button. Fund Name Fund Ticker Symbol Fidelity Select Energy FSENX Templeton Global Bond A TPINX Washington Mutual Investors Fund/A AWSHX c. Print out the information for the mutual fund that you chose to evaluate. d. Based on the information included in this research report, would you invest in this fund? Explain your answer. While student answers will vary, you may want to use this question to stress the importance of evaluating any mutual fund investment. In addition to the Internet, the other sources of information discussed in this chapter could help in the evaluation process FINANCIAL PLANNING CASE (p. 587) Mutual Fund Research Can Make a "Big" Difference 1. Describe the process you used to choose your fund. While each person must answer this question, you may want to use this question to reinforce the need to evaluate any fund before investing money in the fund. 2. Describe the specific sources of information you used to evaluate your fund. Were the sources of information helpful or not? Financial data about a fund can be obtained from printed materials at a library or on the Internet. It always helps to have more than one source when evaluating mutual funds or other investment alternatives. 3. Based on your research, answer all of the questions on Your Personal Financial Planner Sheet 62-- Mutual Fund Evaluation that is located at the end of your text. Your Personal Financial Planner Sheet 62 (Mutual Fund Evaluation) contains 25 questions that can help investors determine if a fund is the right investment to help obtain their financial goals. While the questions on the Mutual Fund Evaluation sheet can help, the checklist is not a cure-all. However, it is a place to start. Students should be encouraged to obtain other information and determine how it affects their potential investment. 4. In a one to two page report, explain your decision to buy or not buy the fund you chose to research. Be sure to indicate if this fund could help you obtain your personal financial goals and what you have learned about evaluating a mutual fund. 16-28 While student answers will vary, it is important for them to use the one to two page report to summarize what information was reported on Personal Financial Planner Sheet 62. They should also describe any additional information they use and provide a justification if they would invest in the fund. CONTINUING CASE (p. 588) 1. What are the major reasons investors purchase mutual funds as reported to the Lawrences by the Financial Advisor? The major reasons why financial advisors recommend mutual funds for people like Shelby and Mark Lawrence are professional management and diversification. While discussing this question, you may want to remind your students that for most investors, mutual funds are a long-term investment vehicle designed to accomplish long-term investment goals that include retirement, financing college education for their children, or building financial security. Also, you may want to remind students that even though mutual funds are professionally managed, they must still evaluate any fund investment. 2. The Lawrences are concerned about the costs associated with mutual funds. Describe how the Financial Advisor is likely to explain the differences between load funds and no-load funds. Fees for a load fund may be as high as 8 ½ percent. While many exceptions exist, the average load charge for mutual funds is between 3 and 5 percent. A no-load fund is a mutual fund in which no sales charge is paid by the individual investor. While discussing the answer to this question, you may want to review Exhibit 16-3 on page 564 for a description of fees associated with fund investments. 3. Explain how Shelby and Mark might use the Personal Financial Planner sheet Mutual Fund Evaluation. Personal Financial Planner sheet 62 (Mutual Fund Evaluation) would be especially useful because it provides a number of questions about a mutual fund and the securities contained in a fund that could guide the search for a quality investment. 16-29 TM 16-1 Typical Fees Associated with Mutual Fund Investments (Exhibit 16-3) 16-30 TM 16-2 Financial Information about Mutual Funds Available in The Wall Street Journal 16-31 TM 16-3 Advantages and Disadvantages of Investing in Mutual Funds (Exhibit 16-7) 16-32 Name ______________________________________ Cha pt er 16: I nv est ing in M ut ua l F unds 4. A individual who helps investors decide when to switch their investments from one fund to another fund, usually within the same family of funds. 6. A mutual fund in which investors pay a commission (as high as 8 1/2 percent) every time they purchase shares. 8. The current market value of the securities contained in the mutual fund's portfolio minus the mutual fund's liabilities divided by the number of shares outstanding. (abbreviation) 11. An investment chosen by people who pool their money to buy stocks, bonds, and other financial securities selected by professional managers who work for an investment company. 12. A 1 to 5 percent charge that shareholders pay when they withdraw their investment from a mutual fund. 14. A firm that, for a management fee, invests the pooled funds of small investors in securities appropriate to its stated investment objective. 15. A service provided by an investment company in which shareholder income dividends and capital gain distributions are automatically reinvested to purchase additional shares of the fund. 1. A mutual fund in which the individual investor pays no sales charge. 2. The payments made to a fund's shareholders that result from the sale of securities in the fund's portfolio. 3. The earnings a fund pays to shareholders from its dividend and interest income. 5. A fund that invests in the stocks contained in a specific stock index, like the Standard & Poor's 500 stock index, and whose shares are traded on a stock exchange. 7. A group of mutual funds managed by one investment company. 9. A fee that an investment company levies to defray the costs of advertising and marketing a mutual fund. 10. A mutual fund whose shares are issued by an investment company only when the fund is organized. 13. A mutual fund whose shares are issued and redeemed by the investment company at the request of investors. Across Down E X C H A N G E T R A D E D F U N D C O N T I N G E N T D E F E R R E D S A L E S L O A D C A P I T A L G A I N D I S T R I B U T I O N S I N V E S T M E N T C O M P A N Y R E I N V E S T M E N T P L A N I N C O M E D I V I D E N D S F A M I L Y O F F U N D S C L O S E D E N D F U N D O P E N E N D F U N D M A R K E T T I M E R N O L O A D F U N D M U T U A L F U N D L O A D F U N D 1 2 B 1 F E E N A V 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Instructor Manual for Personal Finance Jack R. Kapoor, Les R. Dlabay , Robert J. Hughes, Melissa M. Hart 9780077861643, 9781260013993
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