Funds: What Are They?
fund is nothing more than a collection of stocks
and/or bonds. You can think of a mutual fund as a
company that brings together a group of people and
invests their money
in stocks, bonds, and other
securities. Each investor owns shares, which represent
portion of the holdings of the fund.
Funds: Different Types Of Funds?
No matter what
type of investor you are, there is bound to be a
mutual fund that fits your style. According to the
last count there are more than 10,000 mutual
funds in North
America! That means there are more
mutual funds than stocks.
It's important to understand that each mutual fund has
different risks and rewards.
In general, the higher
the potential return, the higher the risk of loss.
Although some funds
are less risky than others, all
funds have some level of risk - it's never possible to
away all risk. This is a fact for all investments.
Each fund has a predetermined investment objective
that tailors the fund's assets, regions
and investment strategies. At the fundamental level,
there are three
varieties of mutual funds:
All mutual funds are variations of these three asset
classes. For example, while equity
that invest in fast-growing companies
are known as growth funds, equity funds that invest
only in companies of the same sector or region are
known as specialty funds.
Let's go over the many different flavors of funds.
We'll start with the safest and then work through to the more risky.
Money Market Funds
The money market consists of short-term debt
instruments, mostly Treasury
bills. This is a
safe place to park your money.
You won't get great returns, but you won't have to
about losing your principal.
A typical return is twice the amount you would earn in
a regular checking/savings account and a little less
than the average certificate
of deposit (CD).
Income funds are named appropriately: their
purpose is to provide current income on a
basis. When referring to mutual funds, the terms
"fixed-income," "bond," and
"income" are synonymous.
These terms denote
funds that invest primarily in government and
corporate debt. While
fund holdings may appreciate in
value, the primary objective of these funds is to
a steady cashflow to investors. As such, the
audience for these funds consists of
investors and retirees.
funds are likely to pay higher returns than
certificates of deposit and money market
but bond funds aren't without risk. Because there are
many different types
of bonds, bond funds can vary
dramatically depending on where they invest. For
a fund specializing in high-yield junk
bonds is much more risky than a fund that invests
in government securities. Furthermore, nearly all
bond funds are subject to interest rate
means that if rates go up the value of the fund goes
The objective of these funds is to provide a balanced
mixture of safety, income and capital
appreciation. The strategy of balanced funds is to
invest in a combination of fixed income
A typical balanced fund might have a weighting of 60%
equity and 40%
fixed income. The weighting might also
be restricted to a specified maximum or minimum
each asset class. A similar type of fund is known as an asset allocation
are similar to those of a balanced
fund, but these kinds of funds typically do not have
hold a specified percentage of any asset class. The
portfolio manager is therefore given
freedom to switch
the ratio of asset classes as the economy moves
through the business
Funds that invest in stocks represent the largest
category of mutual funds. Generally, the investment
objective of this class of funds is long-term capital
growth with some income.
There are, however, many
different types of equity funds because there are many
different types of equities.
A great way to understand
the universe of equity funds is to use a style box, an example of which is below.
The idea is to classify funds based on both the size
of the companies invested in and the investment style
of the manager. The term value refers to a style of
investing that looks
for high quality companies that
are out of favor with the market. These companies are
characterized by low P/E and price-to-book
ratios and high
dividend yields. The opposite
of value is growth,
which refers to companies that have had (and are
expected to continue
to have) strong growth in
earnings, sales and cash flow. A compromise between
value and growth is blend, which simply refers to
companies that are neither value nor growth stocks
are classified as being somewhere in the middle.
For example, a mutual fund that invests in large-cap
companies that are in strong financial
shape but have recently seen their share prices fall would be
placed in the upper left
quadrant of the style box
(large and value). The opposite of this would be a
invests in startup technology companies with
excellent growth prospects. Such a mutual fund would
reside in the bottom right quadrant (small and
fund (or foreign fund) invests only outside your
home country. Global funds invest anywhere around the
world, including your home country. It's tough to classify these funds as either riskier
or safer than domestic investments. They do tend
to be more volatile
and have unique country
risks. But, on the flip side, they can, as part
a well-balanced portfolio, actually reduce risk by
increasing diversification. Although
economies are becoming more inter-related, it is
likely that another economy somewhere is outperforming
the economy of your home country.
This classification of mutual funds is more of an
all-encompassing category that consists of funds that have proved to be popular but don't necessarily
belong to the categories we've described so far. This
type of mutual fund forgoes broad diversification to
a certain segment of the economy.
funds are targeted at specific sectors of the
economy such as financial, technology, health, etc.
Sector funds are extremely volatile.
There is a greater possibility of big gains,
have to accept that your sector may tank.
funds make it easier to focus on a specific area
of the world. This may mean
focusing on a region (say
Latin America) or an individual country (for example,
An advantage of these funds is that they
make it easier to buy stock in foreign countries,
which is otherwise difficult and expensive. Just like
for sector funds, you have to accept
the high risk of
loss, which occurs if the region goes into a bad recession.
funds (or ethical funds) invest only in companies that
meet the criteria
of certain guidelines or beliefs.
Most socially responsible funds don't invest in
such as tobacco, alcoholic beverages,
weapons or nuclear power. The idea is to get
competitive performance while still maintaining a
The last but certainly not the least
important are index
funds. This type of mutual fund
performance of a broad market index such as the S&P
500 or Dow
Industrial Average (DJIA). An investor in an
index fund figures that most managers can't
market. An index fund merely replicates the market
return and benefits investors
in the form of low fees.
Funds: The Costs?
Costs are the
biggest problem with mutual funds. These costs eat
into your return, and
they are the main reason why the
majority of funds end up with sub-par performance.
What's even more disturbing is the way the fund
industry hides costs through a layer of
financial complexity and jargon. Some critics of the industry
say that mutual
get away with the fees they charge
only because the average investor does not understand
what he/she is paying for.
Fees can be broken down into two categories:
1. Ongoing yearly fees to keep you invested in the
2. Transaction fees paid when you buy or sell shares
in a fund (loads).
The Expense Ratio
The ongoing expenses of a mutual fund is represented
by the expense ratio. This is
sometimes also referred
to as the management
expense ratio (MER). The expense ratio
composed of the following:
� The cost of hiring the fund manager(s) - Also
known as the management fee, this cost
is between 0.5%
and 1% of assets on average. While it sounds small,
this fee ensures
fund managers remain in the country's top echelon
of earners. Think about it
for a second: 1% of 250
million (a small mutual fund) is $2.5 million - fund
managers are definitely not going hungry! It's
true that paying managers is a necessary fee, but
think that a high fee assures superior
� Administrative costs - These include necessities
such as postage, record keeping,
service, cappuccino machines, etc. Some funds are
excellent at minimizing
these costs while others (the
ones with the cappuccino machines in the office) are
� The last part of the ongoing fee (in the United
States anyway) is known as the 12B-1
fee. This expense goes toward paying brokerage
commissions and toward advertising
and promoting the
fund. That's right, if you invest in a fund with a
12B-1 fee, you are
paying for the fund to run
commercials and sell itself!
On the whole, expense ratios range from as low as 0.2%
(usually for index funds) to as
high as 2%. The
average equity mutual fund charges around 1.3%-1.5%.
generally pay more for specialty or
international funds, which require more expertise
In case you are still curious, here is how certain
� Front-end loads - These are the most simple type
of load: you pay the fee when you
purchase the fund.
If you invest $1,000 in a mutual fund with a 5% front-end
will pay for the sales charge, and $950
will be invested in the fund.
� Back-end loads (also known as deferred sales
charges) - These are a bit more
complicated. In such a
fund you pay the a back-end
load if you sell a fund within a
frame. A typical example is a 6% back-end load that
decreases to 0% in the seventh year. The load is 6% if
you sell in the first year, 5% in the second year,
If you don't sell the mutual fund until the
seventh year, you don't have to pay the
fund sells its shares without a commission or
sales charge. Some in the mutual
fund industry will
tell you that the load is the fee that pays for the
service of a broker
choosing the correct fund for you.
According to this argument, your returns will be
higher because the professional advice put you into a
better fund. There is little to no
evidence that shows
a correlation between load funds and superior
fact, when you take the fees into account, the average load fund performs worse than
Funds: How to Pick a Mutual Fund?
You can buy some mutual
funds (no-load) by contacting the fund companies
Other funds are sold through brokers, banks,
financial planners, or insurance agents. If you
through a third party there is a good chance they'll
hit you with a sales charge (load).
That being said, more and more funds can be purchased
through no-transaction fee
programs that offer funds
of many companies. Sometimes referred to as a
"fund supermarket," this service lets you
consolidate your holdings and record keeping,
still allows you to buy funds without sales charges
from many different companies.
Popular examples are
Schwab's OneSource, Vanguard's FundAccess, and
FundsNetwork. Many large brokerages have
Selling a fund is as easy as purchasing one. All
mutual funds will redeem (buy back)
your shares on any
business day. In the United States, companies must
the payment within seven days.
The Value of Your Fund
asset value (NAV), which is a fund's assets
minus liabilities, is the value of a mutual
fund. NAV per share is the value of one share in
the mutual fund, and it is the number
that is quoted in newspapers. You can basically just think of NAV per
share as the
price of a mutual fund. It fluctuates
everyday as fund holdings and shares outstanding
change.When you buy shares, you pay the current NAV per share
plus any sales
front-end load. When you sell your
shares, the fund will pay you NAV less any back-end
Funds: How To Read A Mutual Fund Table?
1 & 2: 52-Week High and Low - These show the
highest and lowest prices
the mutual fund has experienced over the previous 52 weeks
(one year). This typically
does not include the
previous day's price.
Column 3: Fund Name - This column lists the
name of the mutual fund. The company
that manages the fund is written above in bold type.
Column 4: Fund Specifics - Different letters
and symbols have various meanings.
"N" means no load, "F" is front
end load, and "B" means the fund has both
front and back-end fees. For other symbols see the
legend in the newspaper in which
you found the table.
Column 5: Dollar Change -This states the dollar
change in the price of the mutual fund
from the previous day's trading.
Column 6: % Change - This states the percentage
change in the price of the mutual
fund from the previous day's trading.
Column 7: Week High - This is the highest price
the fund traded at during the past week.
Column 8: Week Low - This is the lowest price
the fund traded at during the past week.
Column 9: Close - The last price at which the
fund was traded is shown in this column.
Column 10: Week's Dollar Change - This
represents the dollar change in the price of
mutual fund from the previous week.
Column 11: Week's % Change - This shows the
percentage change in the price of
the mutual fund from
the previous week.