Investing to Achieve

Investing to Achieve

Financial Independence

Created by LSUE Students In Free Enterprise

Mutual Funds

What is a Mutual Fund?

Mutual Fund combines the money of many people that have similar investment interests and goals. Professional investment managers invest the pooled money in a large number of different securities from the stock, bond, and treasury markets.

When you buy a share of a mutual fund, you buy a small interest in each of the types of investments made by the money manager. This helps reduce the market risk by smoothing out the normal ups and downs that occur in the price of individual securities.

Mutual Fund investments allow you to benefit from the expertise of the professional money managers who are highly skilled and dedicate their time and available resources to study individual companies and general economic trends.

Closed End vs. Open End

There are two broad categories of Mutual Funds, closed end and open end. A closed end fund sells its shares either over-the-counter or through one of the major stock exchanges. If an owner of shares in a closed end fund wishes to sell their shares, they must find a buyer to purchase them. An open-end fund is what most people associate with a "Mutual Fund". An open-end fund sells shares to investors and also agrees to buy back the shares at their Net Asset Value (NAV) at any time in the future.

Load vs. No Load

Mutual Funds can be further categorized as load funds or no load funds. Load funds have a sales charge when you purchase or sometimes when you sell your shares. These loads may be "front end" or "backend" Back end loads are usually referred to as "contingent sales loads." Front-end load is an immediate sales charge added to the NAV of the fund. The front-end load immediately reduces the value of your investment. These sales charges are in addition to management fees that are charged by the fund company. No load funds do not have sales charges when the shares are bought or sold. Both load and no load funds charge management fees, which are ongoing fees charged by the fund’s investment advisor for managing the fund and selecting its portfolio of securities. Some funds may also charge for advertising expenses as well. Known as 12b1- fees, these are used by some funds to pay for marketing and distributing expenses.

Types of Mutual Funds

Categorizing funds according to their investment objectives is a common practice in the mutual fund industry, doing so reflects not only how the funds invest their money, but also their risk and return characteristics. There are four very basic types of mutual funds: money market funds, bond funds, balanced funds (also called hybrid funds), and stock funds (also referred to as equity funds).

Money Market Funds have relatively low risks compared to other mutual funds. These funds are limited by law to certain high-quality, short-term investments.
Bond Funds have higher risks than money market funds, but they seek to pay higher returns. Unlike money market funds, bond funds are not restricted to high- quality or short-term investments. Because there are many different kinds of bonds, the bond fund can vary considerably in their risks and returns.
Stock Funds or (Equity Funds) generally involve more risk than a money market or bond fund, but they also can offer the highest returns. A stock fund’s value (NAV) can rise and fall quickly, but historically stocks have performed better over the long term than other types of investments.
Balanced Funds or (Hybrid Funds) seek capital gains and income which are earned from a mix of investments from money markets to bonds and stocks. Money markets provide safety for short-term returns, bonds add stability while stocks provide growth.

Why invest in a Mutual Fund?

nvesting does not have to be complicated, time-consuming or something only the wealthy can afford. Buying a mutual fund can be done with ease, and most can be purchased in person, telephone, or mail. When you invest in a mutual fund, you gain the expertise of a professional management team. These investment professionals have years of experience in analyzing market data, choosing securities to meet the funds objectives, and deciding when to trade the holdings. Another reason to invest in mutual funds is diversity. Simply put, you don’t have all your eggs in one basket. The money you send in to the fund is pooled with other investors and buys dozens or even hundreds of securities on your behalf. This greatly reduces your investment risk. Rather than depending on the success of just one, or a few securities, your investment benefits from the stability and growth potential of a broad portfolio. Mutual funds are extremely liquid. This means that it is easy to get your money if you need it. When you sell your shares back to the fund, your money will generally be ready the next business day, or at the latest within five business days. Along with investing, unfortunately comes record keeping. This is where the mutual fund can take a load off your shoulders. All mutual fund companies provide its investors with regular statements detailing all transactions, income earned, and the total value of funds held. They also provide their investors with yearly statements detailing the tax status of all earnings from the fund, including dividends and capital gains information.

Choosing a Mutual Fund

First things first, take time to assess your investment goals and risk tolerance. Next, examine the funds past performance. Although this does not indicate future results, it is a good place to start. Make sure you understand what the fund owns and how it invests. Keep an eye on costs. Given two equally appealing mutual funds, consider choosing the lower- cost fund. The more money you give to the fund, the less you keep for yourself. Next, be sure that the fund manager who compiled the portfolio that you are interested in is still with the fund. Funds are only as good as the people who manage them. Knowing the fund manager is an important factor in choosing the right fund.

Dollar Cost Averaging

ne of the most effective investment strategies you can employ is to dollar cost average. It is a simple approach that literally works all by itself. Each month you contribute the same amount of dollars to the same investment. You do this no matter how the financial market fluctuates. These contributions are made by the individual or are deducted from your paycheck each month. By having these contributions taken out of your paycheck, you learn to budget your personal expenses without having to think about the money being deducted.

The end result will be money safely invested that will enhance your retirement. It also takes the risk out of constantly trying to analyze the market on your own. Dollar cost averaging will keep you on a course that eliminates the constant switching back and forth if you were attempting to invest on your own. This effective approach allows you to buy more shares when prices decline. This will enable you to obtain a lower average cost per share than if you were to invest a large sum at one

time. This keeps your market risk at a minimum in a market that is always in a state of fluctuation.

The dollar cost averaging approach does not protect against a decline in market prices. It does, however, provide a way for reducing anxiety over movements in the investment markets. Find the investments you are comfortable with and stay with them. This approach is a long-term strategy and staying the course is a must to achieve your investment goals.

Compounding Interest

ompounding interest is the return generated by interest earned on both the investor’s principal and the interest earned in previous time periods. In simpler terms, compounding interest is interest earned on top of interest and original deposit. For example, suppose you deposited $1.00 yesterday and earned one-cent of interest. Today you’ll be earning interest on $1.01. When dealing with mutual funds, compounding involves earning dividends on top of dividends and earning capital gains on capital gains.

You can double your money in a short amount of time by using compounding interest. Using the rule of 72, your money can double in just five years, assuming a 14% return. Rule 72 says that if you take the number72 and divide it by the rate of return, it will give you the time in years it will take to double your money. By following this simple advice, you will find out that compounding is one of the most powerful components of investment success.

Many people say that they can’t invest now because they want to finish paying off a student loan or remodel their house. "What if you don’t have $1,000?" Here’s your answer. If you can save just $5 a month, you can still make money with compounding interest.

A great idea for anyone with future children or grandchildren is starting a mutual fund for that child. Years later, when they start thinking about college or retirement, they will already be way ahead.

IRA’s

Traditional IRA

traditional (also referred to as a contributory IRA) is an account that you may establish to save money for retirement. You may place up to $2000 of your earned income in an IRA until you turn 70 ½. You may also contribute an additional $2000 a year of earned income in a separate IRA for your non-income-earning spouse. The advantages of placing money into a traditional IRA are:

The earnings (interest, dividends, capital gains) are not taxed as long as the funds remain in your IRA.
Depending on your income and whether you or your spouse are covered by an employer’s retirement plan, some or all of your IRA contribution may be tax deductible.

Although traditional IRAs carry tax advantages, they are subject to various tax rules. Three of the most important rules are:

Withdrawal from an IRA is taxed as ordinary income tax in the year in which you make the withdrawal. (If you have made nondeductible contributions to your IRA, a portion of your withdrawal may not be taxable)
If you withdraw funds from your IRA before you turn 59 ½, those funds are subject to a 10 % federal penalty unless an exception applies. Exceptions include withdrawals due to your disability, qualified higher education expenses, the first-time

purchase of a home ($10,000 lifetime limit), some uninsured medical expenses, and certain unemployment related expenses.
After you turn 70 ½, you must begin taking annual withdrawals from your IRA. The amount of each withdrawal is based on IRS life expectancy tables.

Roth IRA

amed for Senator William Roth of Delaware, the Roth IRA offers many advantages over the traditional IRA. Joint filers may each contribute up to $2,000 of their income into a Roth IRA as long as their combined income is less than $150,000. You can withdraw up to $10,000 tax free to purchase a first home provided the money has been in the Roth for five years. You can even withdraw up to the total amount deposited without penalty, for disability or certain medical emergencies. Once you have reached the age of 59 ½, and your assets have been in the Roth IRA for at least five years, all withdrawals are tax-free. Both traditional and Roth IRAs allow withdrawals after the age of 59 ½, but unlike the traditional IRA, the Roth will permit contributions after the age 70 ½ and does not require withdrawals on any particular schedule.

IRA Comparison

Feature	Traditional IRA	Roth IRA
Annual Contribution Limits (same for taxpayer and spouse)	Up to $2000 of earned income ($4000 for joint-filers)	Up to $2000 of earned income ($4000 for joint-filers)
Eligibility	Under the age of 70 ½	Any age when single and joint filers, although certain income limits apply.
Tax- deductible contributions?	Fully deductible if income is below single or married income levels.	Nondeductible
Distributions	Must begin at age 70 ½	Not mandatory at age 70 ½
Tax on earnings when drawn after the age 59 ½?	Yes	No, if held for more than five years.
Maximum income limit for contributions?	No	Yes, $100,000 for individuals and $150,000 for couples filing jointly.
Penalty-free withdrawals?	No	Yes, for first time home purchase, disability or other pressing need if made after five years of the first contribution.
Contributions after 70 ½?	No	Yes

401 (k)

What is a 401(K) plan?

A 401(K) is a special type of tax-qualified retirement plan that allows employees to save and invest for their own retirement. Through a 401(K) plan, employees are allowed to deduct a certain amount of money, usually by a percentage, from their salary on a pre-tax basis to invest in this plan. A typical 401(K) plan allows employees to contribute up to 20% of their salary or a total of $10,000 per year. The company that offers the 401(K) plan decides which investments it will make available in the plan. The quality of a 401(K) plan is dependent on the quality of investment vehicle selections employees can choose from. Some companies have an excellent 401(K) plan that offers a host of high quality investment options and may allow changes among mutual funds or any other choices within the plan. A 401(K) plan is a remarkable investment vehicle to use for your retirement.

How does a 401(K)-plan work?

The employees choose how much money they want to deduct from their salary. With this decision, they can select how to invest this contribution, choosing from the company’s investment plan options.

The selection plan may include the following: Mutual funds, S&P 500, money market and company stock.

Benefits of a 401(K) plan

Tax-deferred contributions and earnings make up the best one-two punch in investing. Before being taxed, your money is put into your 401(K) plan and allowed to grow with your earnings. Taxes are paid when the money is taken out.

Reduced taxes. A contribution in a 401(K) plan helps reduce your federal and state income taxes by lowering your taxable income.

Company match provision. Most employers offer employees a matching percentage (25%, 50% or 100%) or a set dollar amount of the money that is being vested within the 401(K) plan.

Instant savings.

Examples of a 401(K) plan

Joe Shaw open a 401(K) plan where he’s currently employed. He contributes 8% out of his payroll earning ($35,000) on a pre-tax basis. At the same time his company is matching 50 % of every dollar that Joe Shaw contributes.

Here are Joe Shaw contributions into his 401(K).

$2,000- 401(K) Employee contribution

$1,000 -401(K) Company contribution

$3,000- Total contribution

Mutual Fund Glossary

Asset Allocation:

A strategy for keeping investments diversified. Fixed asset allocation plans set specific amounts or percentages in different areas and adjust the portfolio to match them. Active asset allocation plans vary the allocation depending on market conditions.

Average annual return:

The annual returns which, when compounded over a number of years, equal the total return for the same period. This is the average amount per year you would have made on the fund.

Bond:

A debt security issued by a government or corporation that promises to pay a stated rate of interest and to return the face value on a specific maturity date.

Capital Appreciation:

An increase in the value of a mutual fund investment.

Capital Gains or Loss:

An increase or decrease in the values of shares held in a mutual fund. It is calculated as the difference between the price you pay for a fund and the price you sell it for.

Common Stock:

A security representing ownership in a company.

Distribution:

A payment of income by a mutual fund to its shareholders.

Dollar-cost averaging:

A voluntary method of investing in which you invest a fixed amount of money on a regular basis, regardless of market conditions. While it does not ensure a profit or protect against loss in declining markets dollar-cost averaging enables you to buy more shares when prices are down and fewer shares when they are high.

Expense Ratio:

The expense ratio equals the expenses incurred by the fund divided by total assets under management. The ratio is listed in a fund’s report. The lower a fund’s expense ratio, the more money you get to keep from your investment earnings.

Fluctuation:

The increase or decrease in the value of mutual fund investment.

GNMA:

A security insured against default by the government national mortgage association. It represents an interest in a group of fixed rate home mortgage.

Individual Retirement Account (IRA):

A retirement plan that allows you to contribute up to 2000 dollars of earned income annually in a plan in which earnings grow tax deferred until withdrawal. Many people can fully or partially deduct IRA contributions from their federal tax income.

Interest Rate:

The cost of money expressed as a percentage rate for a period of time, usually one year.

Load:

A sales charge that you pay when buying fund shares through a broker or financial planner. Some funds that sell their shares directly to the public also charge loads. A charge imposed when you sell your shares is called redemption or back in load.

Management Fee:

The fee paid to an investment manager for making investment decisions for the fund and monitoring the holdings on a daily basis. The management fee is normally calculated as a percentage of the fund’s total assets.

Mutual fund:

An investment in which money from a group of investors with a common investment objective is combined to buy and sell securities to achieve that objective.

Net asset value:

A fund’s per shares value on any given day. A mutual fund calculates net asset value by totaling the worth of cash and securities in the fund, subtracting expenses and dividing the remainder by the number of shares owned by investors.

No-load fund:

A mutual fund that does not charge a commission when you buy or sell.

Open-end mutual fund:

A mutual fund that continuously offers to sell and redeem shares at their current net asset value.

Operating expenses:

The costs incurred by the fund to pay the costs associated with the fund’s operation.

Prospectus:

A legal document that provides detailed information about a fund, such as its investment objective and investment philosophy. Mutual funds are required by law to provide individuals with a prospectus before they invest.

Total Return:

A measure of a fund’s performance, total return takes into account reinvested dividends, capital gains or losses and any increase or decline in the value of shares over a given time period.

Yield:

The approximate dividend income that funds pay in a period of time, expressed as a percentage of the fund’s net asset value.

401 (K) plan:

Section 401 (K) of the internal revenue code allows employees to invest pre-tax contributions in a tax deferred retirement plan.

403 (B) plan:

Section 403 (B) of the internal revenue code permits employees or certain non-profit organizations such as schools and hospitals to set up tax-deferred retirement plans.

Mutual Fund Web Sites

SITE ADDRESS

Microsoft Investor www.investor.msn.com

Vanguard www.vangard.com

DBC Online www.dbc.com

The Motley Fool www.fool.com

Investools www.investools.com

Morningstar www.morningstar.net

CNNFN www.cnnfn.com

Yahoo! Finance http://quote.yahoo.com

Briefing.com www.briefing.com

Wall Street City www.wallstreetcity.com

Ameritrade www.ameritrade.com

American Stock Exchange www.amex.com

Smart Money www.smartmoney.com

Fund Advice www.fundadvice.com

Fidelity Investments www.fidelity.com