on any of the topics in the Table of Contents listed below to go directly
to that discussion.
Mutual funds are an excellent way to invest in stocks, bonds and other securities. They are a good choice of investment because:
Before getting into our discussion of mutual funds, there are three important points to keep in mind:
Once you determine your asset allocation model, you can implement the recommended portfolio with mutual funds. You need only six to ten funds to achieve diversification and your asset allocation objectives, as opposed to having to buy many more individual securities to achieve the same results.
Once you identify the asset classes that will be represented in your portfolio, itís time to select specific funds in those categoriesi.e., funds that meet your investment goals. To choose wisely, itís necessary to assess:
Most sources of mutual fund recommendations are inadequate. They either
depend solely on past performance or fail to take into account your
particular needs. Newsletters and magazines, for example, often simply
recommend last yearís hot fundówhich, even though it may remain hot
for the current year, may be totally wrong for you.
A fund's past performance is not as important as you might think. Advertisements, rankings, and ratings tell you how well a fund has performed in the past. But studies show that the future is often different. This year's "No. 1" fund can easily become next year's dog.
Here are some tips for comparing fund performances:
Costs are important because they lower your returns. A fund that has a
sales load and high expenses will have to perform better than a low-cost
fund, just to stay even.
The first part of the fee table will tell you if the fund charges any
sales loads. No-load funds (by definition) do not charge sales loads.
There are no-load funds in every major fund category. Even no-load funds
have ongoing expenses, however, such as management fees.
Back-end load: A back-end load (also called a deferred load) is a sales charge you pay when you sell or exchange your shares. It usually starts out at 5% or 6% for the first year and gets smaller each year after that until it reaches zero (say, in year six or seven year of your investment).
The second part of the fee table tells you the kinds of ongoing expenses you will pay while you remain invested in the fund. It shows expenses as a percentage of the fund's assets, generally for the most recent fiscal year. Here, the table will tell you the management fee (for managing the fund's portfolio), along with any other fees and expenses.
High expenses do not assure superior performance. Higher-expense funds do not, on average, perform better than lower-expense funds. But there may be circumstances in which you decide it is appropriate to pay higher expenses. For example, you can expect to pay higher expenses for certain types of funds that require extra work by managers, such as international stock funds, which require sophisticated research.
A difference in expenses that may look small to you can make a big difference in the value of your investment over time.
Rule 12b-1 fee: One type of ongoing fee that is taken out of fund assets has come to be known as a Rule 12b-1 fee. It most often is used to pay commissions to brokers and other salespersons, and occasionally to pay for advertising and other costs of promoting the fund to investors. It usually is between 0.25% and 1.00% of assets annually.
Funds with back-end loads usually have higher Rule 12b-1 fees. If you are considering whether to pay a front-end load or a back-end load, think about how long you plan to stay in the fund. If you plan to stay in for six years or more, a back-end load will usually cost less than a front-end load.
Here are some suggestions for examining a fundís approach to investing.
1. Determine the fundís overall investment objectives.
2. Determine whether the fundís portfolio matches its stated investment objectives. (The fund should fully reveal how it invests.)
3. Determine whether the fund invests overseas.
4. For an equity fund, determine the industry sectors in which itís invested.
5. For a bond fund, determine the years to maturity of its holdings and whether it holds any tax-exempt bonds.
6. Find out how long the fundís management has been in place and whether one particular manager has been responsible for the success of the fund.
Youíll want to find out what services the fund offers. Among the questions you should ask are:
You take risks when you invest in any mutual fund. You may lose some or all of the money you invest (your principal) because the securities held by a fund go up and down in value. What you earn on your investment (dividends and interest) also may go up or down. The various types of risk are:
Each kind of mutual fund has different risks and rewards. Generally, the higher the potential return, the higher the risk of loss. The following discussion of risk for the various types of funds is intended to aid you in choosing a fund that meets your requirements as an investor.
|CAUTION: Contrary to popular belief, NAV may fall below $1.00 if the fundsí investments perform poorly. Although investor losses have been rare, they are possible.
|CAUTION: Banks now sell mutual funds, some of which carry
the bank's name. But mutual funds sold by banks, including money
market funds, are not bank deposits. Don't confuse a "money
market fund" with a "money market deposit account."
The names are similar, but they are completely different:
|CAUTION: Many bank funds are just "private label" funds, i.e., run by a fund family for the bank. This adds an extra layer of cost.
Bond funds (also called fixed-income funds) have higher risks than
money market funds, but usually pay higher yields. Unlike money market
funds, bond funds are not restricted to high-quality or short-term
investments. Because there are many different types of bonds, bond funds
can vary dramatically in their risks and rewards.
Most bond funds have credit risk, the risk that companies or other issuers whose bonds are owned by the fund may fail to pay their bond holders. Some funds have little credit risk, however, such as those that invest in insured bonds or U.S. Treasury bonds. Keep in mind that nearly all bond funds have interest rate risk, which means that the market value of their bonds will go down when interest rates go up. Because of this, you can lose money in any bond fund, including those that invest only in insured bonds or Treasury bonds. Long-term bond funds invest in bonds with longer maturities (the length of time until the final payout). The net asset values (NAVs) of long-term bond funds can go up or down more rapidly than those of shorter-term bond funds.
|TIP: Morningstarís rating system uses specific times to maturity to distinguish between long-term, short-term and medium-term bonds. This system can help you choose the bond fund that is most suitable with regard to interest-rate risk.
Stock funds (also called equity funds) generally involve more riskóvolatilitythan money market or bond funds, but they also offer the highest returns. A stock fund's value can rise and fall quickly over the short term, but historically stocks have performed better over the long term than other types of investments.
Mutual fund rating companies use "beta" to measure risk. Beta measures a fundís price fluctuations relative to those of the whole marketóthat is, its sensitivity to market movements.
Not all stock funds are the same. For example, growth funds focus on stocks that may not pay a regular dividend but have the potential for large capital gains. Others specialize in a particular industry segment such as technology stocks.
The level of volatility in a stock fund depends on the fundís investments, e.g., small-cap growth stocks are more volatile than large-cap value stocks. The level of volatility is also affected by industry sector. Also, international stocks are generally more volatile than domestic stocks.
The foregoing generalizations are intended only as such. It is important, when examining a fund for risk/reward characteristics, to analyze each fund on a case-by-case basis.
|CAUTION: Funds that invest in derivatives face special risks. Derivatives Ė which come in many different types and have many different uses are financial instruments whose performance is derived, at least in part, from the performance of an underlying asset, security or index. Their value can be affected dramatically by even small market movements, sometimes in unpredictable ways. However, they do not necessarily increase risk, and may in fact reduce risk. A fund's prospectus will disclose how it may use derivatives. You may also want to call a fund and ask how it uses these instruments.
There are a number of sources of information that you should explore before investing in mutual funds. The most important of these is the prospectus, which is the fund's selling document and contains information about costs, risks, past performance and the fund's investment goals. Request the prospectus from the fund or from a financial professional if you are using one. Read the prospectus, and exercise your judgment carefully, before you invest.
Read the sections of the prospectus that discuss the risks, investment goals and investment policies of the fund you are considering. Funds of the same type can have significantly different risks, objectives and policies.
All mutual funds must prepare a Statement of Additional Information (SAI, also called Part B of the prospectus). It explains a fund's operations in greater detail than the prospectus. If you ask, the fund must send you an SAI.
You can get a clearer picture of a fund's investment goals and policies by reading its annual and semi-annual reports to shareholders. If you ask, the fund will send you these reports. You can also research funds at most libraries or by using an on-line service.
Provides month by month suggestions and ideas to improve your financial life.
Books And Other Publications
Government And Non-Profit Agencies
The SEC has public reference rooms at its headquarters in Washington, D.C., and at its Northeast and Midwest Regional offices. Copies of the text of documents filed in these reference rooms may be obtained by visiting or writing the Public Reference Room (at a standard per page reproduction rate) or through private contractors (who charge for research and/or reproduction).
Other sources of information filed with the SEC include public or law libraries, securities firms, financial service bureaus, computerized on-line services, and the companies themselves.
Most companies whose stock is traded over the counter or on a stock exchange must file "full disclosure" reports on a regular basis with the SEC. The annual report (Form 10-K) is the most comprehensive of these. It contains a narrative description and statistical information on the company's business, operations, properties, parents, and subsidiaries; its management, including their compensation and ownership of
company securities: and significant legal proceedings which involve the company. Form 10-K also contains the audited financial statements of the company (including a balance sheet, an income statement, and a statement of cash flow) and provides management's discussion of business operations and prospects for the future.
Quarterly financial information on Form 8-K may be required as well.
Anyone may obtain copies (at a modest copying charge) of any corporate report and most other documents filed with the Commission by visiting a public reference room or by writing to:
Public Reference Room, Mail Stop 1-2
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-1002
American Association of Individual Investors (offers an annual guide to low-load mutual funds):
625 North Michigan Avenue, Suite 1900
Chicago, IL 60611
Investment Company Institute (a trade association of fund companies that publishes an annual directory of mutual funds):
1401 H Street NW, Suite 1100
Washington, DC 20005
Mutual Fund Education Alliance (publishes an annual guide to low-cost mutual funds):
1900 Erie Street, Suite 120
Kansas City, MO 64116
|Mutual Fund Scoreboard
|Manhattan Analytics, Inc.
|Morningstar Mutual Funds On Disc
|Mutual Fund Expert Pro Plus
|Alexander Steele Systems
|Principia for Mutual Funds
Keep in mind that the computer software arena changes quickly, but at least the above information provides a starting point for exploring software availability.
Style boxes can be used to compare funds to see whether their investment approaches have a low, moderate or high risk/return profile. By looking at a fundís style box and investment objectives, you can get a good idea of its approach to investing and the types of securities it favors.
Equity funds are described according to company size (large, medium, or small), and whether a fund is value-oriented, growth-oriented, or a blend. Combining these two variables Ė investment methodology and company size offers a broad view of a fund's holdings and risk level. Thus, for equity funds, there are nine possible style combinations, ranging from large capitalization/value for the safest funds to small capitalization/growth for the riskiest.
An example of a equity fund style box is shown below.
Generally, all fund in the upper-left box (Fund A) would carry the least risk, while a fund in the lower-right box (Fund I) would carry the most risk.
Fixed-income funds are described according to their time to maturity (sensitivity to interest rate changes) and their credit quality.
As with equity funds, nine possible style combinations exist, ranging
from short maturity/high quality for the safest funds to long maturity/
low quality for the riskiest.
An example of a fixed-income fund style box is shown below:
As with equity funds, a fund in the upper-left box (Fund R) would carry the least risk and a fund in the lower-right box (Fund Z) would carry the greatest risk.
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