Hi, today we're going to build on our understanding of investments.

By talking about one of the most valuable tools to the average investor,

mutual funds.

The mutual funds are kind of fantastic animal because they provide us

with diversification in the first place.

So they can provide diversification across asset types.

They can provide diversification within asset types.

And when we talk about asset types,

think in terms of a previous discussion we had about stocks and bonds.

So, mutual funds themselves are going to be pooled money,

that's investing into other types of assets.

So this can give us diversification across sectors within an asset type,

even allowing for international diversification.

Because it can be very challenging for the average investor to

build a diversified portfolio by purchasing individual securities.

It's not necessarily cost effective, and usually requires tens of thousands of

dollars to get, to build up to that 12 to 15 broadly chosen securities market that

we talked about in our diversification section.

So, mutual funds allow for this, right, by pulling our assets together, putting

a bundle of investments together that have been heavily researched by experts and

allowing us to buy into a bundle that best fits our needs.

Now one of the things we do want to talk about, though is, because mutual funds,

and there's quite a few of them out there to pick from, we can potentially,

if we pick two or three funds that are achieving the same objectives,

in the end really be investing in the same portfolio over and over again.

So we'll often want to look for things that are a little bit redundant,

in terms of asset holdings within mutual funds that we're selecting.

So what are mutual funds?

Well to put it bluntly if we all combined our money into one big pile and

we took that money and we started buying a bundle of assets with it

that's a lot of what we think of in terms of and managed investments funds.

So a pool of investors money to purchase stocks, bonds, or

potentially even other assets.

And these one of the nice things about them is they do integrate an element of

professional management associated with it.

Now we're not saying to be inconsistent with our efficient market beliefs.

But it allows us to say that this is someone that knows how to

put together a series of assets.

Knows how to achieve a diversified portfolio.

And also understands,

what types of moves are important to make when certain things happen in the market.

And mutual funds also then can have different types of objectives themselves.

Meaning that the timeframe may be more relevant for some investors than others.

Some mutual funds will focus on more liquid assets more

income producing assets.

Others will focus on, on growth.

And of course others will even focus on things like tax exempt municipal bonds.

So, there'll be different goals associated with funds that we'll then want to winnow

through and figure out which one's are the best fit for our investment plan.

So mutual funds are one type of pooled portfolio funds.

We're going to focus on them a lot, but

I don't want to ignore the fact that there's other considerations too.

Closed-end funds are a lot like mutual funds but they're now traded on exchanges.

Whereas mutual funds, we'll see, we simply go back and

forth from the mutual fund company itself.

Which is kind of a nice piece there, so

the mutual fund issuer sells them, we may be buying them through a broker dealer.

But when we want our money back, we simply go back to the fund and redeem our shares.

With a closed end fund if we don't want to hold that asset anymore we do have to

sell it on the exchanges.

Now, there's also things called unit investment trusts.

These are unmanaged and

they're self-liquidating, usually having short-term debt securities.

And a lot of these UITs are, often times, for large investors as a result.

On the other side of things,

there's variable annuities, which behave a lot like a mutual fund.

They are of course, more of an insurance product, as we know.

But maybe something that allows us to achieve this type of pooled portfolio, but

again, focusing on producing in the end a fixed income or

a, a consistent income source for retirement.

And then we also have hedge funds, which many people have heard of.

These are typically organized as offshore limited partnerships for

qualified investors.

They have a lot of investment flexibility, but

they often require substantial amount of capital to be involved.

So because of that, you'll see we focus on mutual funds because for

the average investor, this is one of the more accessible vehicles.

In fact we'll see mutual fund like instruments in

many 401(k) plans, 403(b)plans.

And we can certainly hold mutual funds should we go through an IRA or

Roth IRA as well.

So why might you invest in mutual funds?

Why would we look into that?

Well, number one,

they help manage investment risk by facilitating diversification.

They can allow us to look at asset allocation in a very simple light,

rather than having to do a lot of examination about individual securities.

We can read a prospectus that's provided to us by the Investment Company to

learn more about what the asset allocation is within that fund, and

therefore fitted into the jigsaw puzzle of our own investment plan.

And the other nice piece is that, the professional management for

this fund is usually tied to a specific objective, growth or income.

And so as a result, right,

these type of funds,allow it to take some of the pressure off of us

as individual investors, in not having to make a lot of decisions.

We need to pick a big bundle of investments.

We don't need to figure out each and

every one of our investments in the portfolio full year.

So, the thing to kind of realize is many of us are going to be in mutual funds at

some point because they are the common vehicle or

at least some version of them with an employer provided retirement plan.

So advantages of mutual funds one hand, low initial investment,

often times providing for diversification.

There's a whole host of variety, there's thousands of funds to pick from,

so there's a flavor usually for almost everything we need.

We can access them direct, through companies.

We can access them through retirement plans.

We can access them through a broker dealer.

So there's a lot of different conduits, to excessive, to accessing mutual funds, and

often, if we don't have a lot of capital to start off with.

Mutual funds will allow us to get in for lower amounts of money.

Some as low as $25 a month, believe it or not.

Now, fees associated with mutual funds are subtracted through, subtracted from

the investment returns before you're going to get your money disbursed to you.

So, there's a tax efficiency associated with the fees in the sense that we

would only be taxed on the money that we've received,

not on all the revenue generated in our names.

Of course, there's a liquidity element, even though a mutual fund may be up or

down, that's a concern.

But they're isn't a marketability issue, because if we want to redeem our shares,

we simply can do that through the investment company itself.

Hence, there's some advantages form a liquidity standpoint.

And, also as we're getting mutual funds, as we mentioned before,

to buy the same bundle of investments would cost us a lot in transaction fees.

Because to buy an individual stock to go long on a stock,

we're going to have to pay some sort of broker dealer fee.

If we need to do that for 15 or 20 stocks, that's going to add up a lot.

If we just buy into a mutual fund and

buy a reasonable number of shares for the same amount of money we wanted to invest,

we'll probably just have the one transaction cost up front.

We're talking about some of the other elements associated with the expenses, but

that'll be in just a slide or two.

What are some of the disadvantages in a mutual fund?

Well, because there's a professional manager involved,

there are fees associated with it, so there can be some issues of

performance where they might slightly underperform the market.

There's a lot of choices out there, and sometimes that can be overwhelming to us.

One of the nice things about employer provided plans are,

you won't have the universe of choices of mutual funds.

You'll usually get to select within a family of funds.

And to be honest, probably only a few of those from that family of funds.

So there's a lot of choices if we just go out there in the world, and

just say, what mutual fund should I pick?

There's also some classification system issues.

We'll look at the names that are often associated with mutual funds, and

at times those names can be a little misleading.

They don't always name the exact same thing so that's why whatever we're looking

for, we'll want to read the perspective, which is the detailed information they're

required to provide us, before we commit our funds to mutual funds.

Again, a few other pieces there too, the expenses associated with it of course.

And there can be potentially the type of analysis that's being done might actually

be quite limited in nature in the sense they might be focusing on a particular

sector or focusing on a specific subset of a, of a market index like the S&P 500.

Now, closed-end investment companies then they have this fixed capital structure.

The shares are bought and sold in the secondary markets.

Because they're bought and

sold in the secondary markets the value of a closed-end mutual fund share,

can be more than just what it's worth, it could have a premium or a discount.

Because of the supply and demand factor.

Mutual funds, on the other hand, will really just sell at the net asset value,

which is the value per share of the mutual fund when we take all the assets that it

owns, minus any liabilities that it has, divided by the number of shares.

So, there's often a tendency for

shares to sell at a discount, then, from net asset value.

So how do we make money off of mutual funds?

That's always the question I'm interested in.

Well, number 1, if it's a stock fund for example and

they're paying dividends, those dividends get distribute to the fund,

you get your pro rata portion of those as well.

Mutual fund shares themselves can appreciate in value in which case they

can generate a capital gain that way.

So that's one of the issues.

Plus, if the assets within the mutual funds have capital gains,

those are passed through to the investor as well.

If this is a mutual fund that sells at a discount or premium, a change in

the discount or premium can also be a source of revenue to the investor.

And a reminder then, mutual funds as a rule, are pass through entities.

In other words, all the revenue they generate, after they account for

their expenses, need to be passed through to the investors themselves.

So, what are some of the fees associated with mutual funds?

Well, the first fee is called a load.

Now this is really like a commission, is the best way to describe it.

This can be charged up front.

So let's say, for example, you put in $1,000 into a mutual fund and

there's a 1% load, then you're going to be paying that $10 right up front, and

then you'll be investing $990 into the mutual fund.

There's a deferred sales charge also which is commonly called as the back-end load.

The back-end load,

is going to be charged when you withdraw money from the mutual fund.

Now the nice thing about this and

it's often called a contingent preferred sales charge, is that

the percentage charged when you withdraw your money, goes down over time, and

in fact, if you hold a mutual fund long enough that has a deferred sales charge,

that charge could eventually go to zero if you held the fund for let's say ten years.

Now, mutual funds also have to promote and

market themselves as most products do, so they charge a 12b-1 fee.

Why 12b-1?

That's the item they came up with it.

So, 12b-1 fees are these marketing fees that are passed through,

maximum of about 1%.

And that's going to be something that's also charged up

annually to the mutual fund as you're holding it.

Now, in addition there can be a redemption fee on a mutual fund, called a back-end

charge, and that's something that can also be accessed, assessed as well.

So, there's a few other additional fees to think about.

We won't review all of them today.

But reinvestment loads, exchange fees,

trailing commissions, account maintenance fees, and

even investment advisory fees can all be charged to mutual fund accounts.

So, it's really important when you're comparing mutual funds,

that you consider the different fee structures of the funds you're comparing.

Don't just all, don't just look at the asset mix, but realizing that the rate of

return often is before they've accounted for the fees that they've charged.

So we're interested when we compare mutual funds to

think about the expense adjusted rate of return from that mutual fund to

see which one is really doing a good job after they charge the money.

So how do we decide about mutual funds?

Well, as always, same types of process.

Think about our objectives, asses the capital that we have,

find an account that's reasonable for

us, and again, if you have an employer provided account, start there

that's usually going to be the most cost effective one you'll get to choose from.

But we might look for anything from full services firms to online trading as well.

There's many different options for accessing mutual funds, if you've already

taken advantage of your employer plan and are looking to go beyond that.

You'll want to examine the funds you can choose from, and

really focus on the ones that are consistent with your objective.

And then look at the other information that's there before deciding all

the different fees that are out there.

Now, we're going to take a look at some screeners that can help us to

take the universe of thousands of mutual funds, down to just a few, so

that we can really just compare the ones that best fit our needs.

So mutual fund portfolios then,

in terms of how they're classified, can be classified by the type of investment.

The investment style, or whether or not they're a market or index portfolio.

So if we think back to our discussion on stocks,

we talked about several indices that tracked the stock market performance.

There are mutual funds, referred to as index funds,

who are really trying to make this market portfolio for us.

In other words, simply, whatever the S&P 500 does,

that S&P 500 mutual fund is going to try and do roughly the same.

Though slightly underperform the index most of the time, but

they're often going to be the closest approximation to the market portfolio.

So what are some examples of these classifications?

Growth funds, which, as you can imagine, focus on companies that are growing.

We expect these to be for the long run.

They also have aggressive growth, too.

And these are more for long run investors.

There's balanced funds, that focus on balancing the asset mix

between different types of style, stocks and bonds for example.

There's income funds.

Now what would those focus on?

Things that produce income consistently.

This could include dividend paying stocks.

It could include high interest bearing bonds.

Could even include prefer,

preferred stock which will pay a very consistent dividend most of the time.

We have growth and income funds.

Ones that focus on a little bit of both objectives.

There can be specialized funds that focus on specific things.

For example, socially responsible funds.

Ones where the investment screening process for

what assets they put into that bundle of portfolios they're selling.

Focus on things that only meet social responsibility goals.

So, for example, they might be avoiding high polluting companies.

Or they might be investing in green industry as a result.

So, as you can imagine then, there's mutual funds that just focus on

individual sectors, biotech, you might focus on energy, or even technology.

Bond funds, index funds we mentioned, tax-exempt bond funds, and

even things like single country or

regional funds, for example, mutual funds that focus on the Asian-Pacific Rim.

Or that focusses on emerging markets.

So, it allows us to capture a bundled portfolio that fits those objectives, but

at the same time, not making us forced to pick the individual securities.

So how do investment advisors select mutual funds?

Well they look at the prospectus.

And then using screeners that look at things like the fund objective,

the investment policy and strategy.The tenure of the manager.

In other words, how long has the person who's in charge of

the portfolio been doing it?

If they've only been there three weeks,

then everything we know about the mutual funds history may be kind of a mute point.

We don't know that this person will follow suit to the patterns we saw in

the perspectives.

On the other hand, if that person's been the manager for a decade, then a lot of

those things we can attribute to their management as a results.

The historical performance is important, but

there's this old adage that we often don't want to chase returns.

So, just because something was the best performer last year,

in no way indicates that it will be the best performer this year.

So we don't want to just look at that solely, but

certainly we want to consider their performance as a whole.

The amount of time that assets are bought and sold within the security,

if we think about that, that can generate capital gains for us.

Now that's nice from an income stand point, but

remember short term capital gains are taxed at our regular income tax rate.

So, for example with a higher portfolio turnover, and

we just held this mutual fund and received income every year we're

potentially going to have a little bit of a higher tax bill as a result of it.

We certainly as we mentioned earlier want to consider the fees and

expenses associated with the mutual fund.

Obviously all things equal we'd like to pay the least amount in fees possible.

What types of issues there are in terms of buying and selling shares.

Any challenges associated with it, the process associated with it.

The minimum initial investment.

If I only have a $1000 to invest,

then looking at mutual funds that require $10,000 to invest doesn't do me any good.

And, of course,

are there any services associated with investors with that family of funds?

That's another thing that we often want to be able to consider if possible.

When we evaluate funds, we often want to think about this pass performance.

These historical returns we talked about on a fee adjusted basis.

We also want to think about on a risk adjusted.

So, the ways we measure risk numerically are through two prin,

principal measures, one is the standard deviation of the returns, right,

the average amount of deviation from the mean.

The higher that is, the more risk we're talking about, and

of course the beta, potentially of the portfolio as well, and

the beta as we know represents that exposure to market risk.

So we, there's 3 different ratios that are used that we'll compare.

So we have the Sharpe measure, the Treynor measure, and the Jensen measure.

And these will all for example, allow us to compare and say, how are these funds

doing accounting for the amount of risk that they're exposed to.

So, Sharpe and Treynor in particular,

are useful when we're comparing two different mutual funds.

The Jensen's alpha looks a little bit at how it's doing relative to how we think it

ought to do, based upon things like the capital asset pricing model, and

of course, whether or not we think that that fund is a good fit for us, too.

So, we mentioned before the cost and fees, also want to mention the ratings which try

and consider a lotta these factors and actually rank these investments for us.

Some of the common ones include Morningstar, Lipper, S&P, and

Thomson Financial.

So all of these provide different ratings available to us to help us think about

whether or not a mutual fund is a good performer relative to its peers, average

performer relative to its peers, or below average performer relative to its peers.

And each one has a slightly different way of presenting it,

Morningstar's famous thing is the star rating of course.

Now how do we then screen these mutual funds?

Well, I recommend the one from FINRA.

That's the financial industry regulatory authority.

It's a nice agency that we can trust a little bit more.

And so this has a nice fund screener available for it too.

And the link of course is in the course web site.

And this allows us, for example, to put in a whole host of things.

For example, what type of investment are we looking for?

What types of expenses are we interested in?

What's the objective of the investment, as well.

So this FINRA screener allows us to winnow down the mutual funds from this big group.

All the way down to just the select few that probably fit our

actual criterion that we have.

So again, taking a look and thinking through that as well and

relying upon fund screeners, to do the heavy lifting for us.

Morningstar, as I mentioned before, is another common one.

They, for equities for example, they have a style box that allows us to

classify investments within their categories.

Value, lend, growth.

And they can be categorized by how big the companies are within the mutual fund.

Large cap, mid cap, small cap.

And so, within those we can say which one are we interested in.

Once we narrow that down, looking at the star ratings again to

help us to find the strongest ones that best fit our needs.

Lipper Averages is another useful point of comparison.

It looks at the average performance in a class of mutual funds.

So in other words, it asks, we get to ask the questions,

does this mutual fund's performance, keep up with the Lipper Average, or

that class of the mutual fund that we're talking about.

So again, another way that we can gauge mutual funds, their fit, and

their appropriateness for, for us as an individual investor.

Now we, mentioned this idea of taxes, so you'll want to mention again.

Mutual funds are passed through entities.

They distribute income in the form of capital gains, interest, dividends.

And all of these are considered taxable, even if they're invested.

So how do we avoid taxes?

Well, remember, if you're holding a mutual fund into a tax deferred account,

like a 401k plan or an IRA plan, then we won't face that income tax every year.

If we're just holding it directly through a brokerage account, like we talked about,

a cash account, for example.

Then this will generate income tax issues for

us every year, as a result, assuming the fund returns a positive investment for us.

So, and we mentioned also that if we redeem our shares,

we can also take on a capital gain as well.

Because if the share, once redeemed, is more than what we paid for

it, that is also a capital gain as well.

So, how do we access mutual funds?

Direct from the mutual fund, a broker dealer, individual retirement accounts or

through our employer retire, employee retirement plans that are provided to us.

401k's, 403b's, SAP, SIMPLEs, so on and so forth.

The whole absolute the whole alphabet soup.

So, the ways in which we've gotten these mutual funds will dictate the taxation.

So, if we connect those two pieces together, as we mentioned,

if I hold the mutual fund in a tax-advantaged account.

Then I'm going to potentially not have to deal with taxes until a much later

date, right?

If it's within a Roth IRA, remember it was our income that we put into the Roth IRA

that was taxed, all investment proceeds will not be taxed as long as we're

meeting the I, the Roth IRA guidelines of holding it til age 59 and a half.

Holding it for at least five years.

And if we need to take it out before age 59 and a half, only doing so

for first time home purchase or other exceptions [INAUDIBLE].

So to summarize, mutual funds are a powerful investment tool for

the average investor.

There's something that we often have to rely upon in order to achieve

diversification in a cost effective manner.

The professional management for them and

the listing by their objectives allows us to pick the funds that best fit our needs,

and put them into our portfolio, and allow us to not have to worry about the day to

day management of the investment, but trusting in that professional management.

The way that we can sit back, relax, and let our money work for you.

Mutual Funds

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