Investing in Mutual Funds
What is a Mutual Fund?
A mutual fund pools your money with other investors' and the capital is used to invest in a diversified portfolio of securities. Mutual funds are professionally managed to pursue each fund’s specific goal.
As an investor in a mutual fund, you become a shareholder in a large portfolio of stocks, bonds and/or money market securities (or some combination of them). As a shareholder, you are entitled to a share of the capital appreciation, interest and dividends (or losses, as the case may be).
One of the benefits of a mutual fund is the opportunity to obtain greater diversification at a relatively inexpensive cost because generally, your share of the portfolio will cost less than what it would cost to purchase all of the individual securities held separately.
Load vs. No-load Mutual Funds
Those funds that include a sales charge paid by the investor -- usually at purchase, and occasionally when the fund shares are sold -- are called "load" funds. "No-load" funds do not charge this fee.
Typically, a sales charge is present when the mutual fund is purchased through a financial advisor or registered representative. The "load" pays for the financial advice the client receives for selecting his or her investment. "No load" mutual funds are typically used by investors who prefer to make investment decisions without an advisor.
The Mutual Fund Marketplace
Mutual funds have become a popular investment vehicle over the last 20 years. More than 40 million people in the U.S. invest in them. That's one of every three households in America.
The diversification feature of mutual funds tends to reduce the danger of company-specific declines to which investors in individual stocks may be subject. As an individual investor, it can be expensive to try to invest in a broad range of securities. Instead, individual investors tend to buy stock in a smaller number of companies. This exposes them to risk if the price of one of their chosen equities drops sharply.
But the investor in a diversified mutual fund buys a small piece of the entire fund, reducing the exposure to declining individual stocks and benefiting from owning dozens (perhaps hundreds) of different securities.
Although equity mutual funds typically carry more risk than fixed-income securities, they generally offer more capital growth potential. And with thousands of funds available in the marketplace, it is relatively easy to find a fund to meet almost any investment need.
Sales Charge Discount for Load Funds
Mutual fund companies typically offer sales charge discounts to investors who purchase a certain dollar amount of shares in either a specific mutual fund or multiple funds offered by the same mutual fund company.
Each investment purchase level at which the fund company offers a lower sales charge is known as a "breakpoint." An investor may also be entitled to a breakpoint through the following:
"Rights of Accumulation" (ROA) permit a fund shareholder to obtain a sales charge discount on a current purchase if that purchase, added to the shareholder's existing fund holdings, reaches or exceeds a breakpoint level.
A "Combined Purchase Privilege" (CPP) allows a purchaser to reach a breakpoint through ROA by combining his or her fund purchases with the purchases made by his or her family members in the same fund company.
A "Letter of Intent" (LOI) allows a purchaser to receive a sales discount through his or her written promise to purchase sufficient number of fund shares to reach a breakpoint dollar amount within a certain amount of time.
Information on specific breakpoint levels can be found in the prospectus that accompanies each mutual fund. The eligibility for breakpoints, ROA, CPP and LOI vary by fund and are determined by the specific investment company as stated in the prospectus. Before you invest, obtain more complete information about mutual fund charges and expenses, by obtaining and reading the applicable prospectus.
Types of Funds
Before you invest in any fund, it's important to understand its objectives and strategies, which can be found in the prospectus. You want to be sure that the fund is appropriate for your goals and risk tolerance level.
Aggressive Growth Funds seek to provide maximum growth of capital with secondary emphasis on income, and often invest in emerging growth companies that pay small dividends, if any, but with a potential for rapid growth. They are designed for investors who can afford to assume the risk of potential loss while seeking substantial gains.
For instance, small-cap funds, which target smaller companies with greater growth potential and risk, would be classified as aggressive. Such funds are subject to wide variations in value. Another example, sector funds, invest in securities of a specific industry or section of the economy (such as pharmaceuticals, health care, or chemicals); they offer a good opportunity for capital appreciation in a growing industry but also involve the risk of potential loss if an economic downturn hits that particular industry. Sector funds offer less diversification benefits than a broad industry fund.
Growth Funds seek long-term capital growth first and current income second, and tend to favor established companies. Large-cap funds, which tend to specialize in established, dividend-paying companies are often classified as growth funds.
Index funds give the investor a broadly diversified portfolio by buying shares in all of the companies in a broad index, such as the S&P 500 Stock Index or some other benchmark. These funds are generally appropriate for someone who will not need to withdraw funds in the near future.
Growth and Income Funds seek both long-term capital growth and current income, usually by investing in a portfolio of growth and income stocks, or in a combination of growth stocks, income stocks, preferred stocks, convertible securities or fixed-income securities. They are more suitable for investors who want moderate potential for growth and current income along with moderate stability of principal.Balanced funds invest in bonds as well as stocks (Bonds are typically more stable than stocks but bond prices do fluctuate with changes in interest rates. There is still a degree of risk involved if interest rates change.).Asset allocation funds are designed to provide diversification: they combine stocks, bonds and money markets, dividing their assets at the fund manager's discretion to take advantage of the most attractive markets at the appropriate time.
Income Funds have a primary goal of providing current income with capital growth generally of secondary importance, and are more suitable for investors who are able to assume a degree of capital risk. Equity income funds invest primarily in high-dividend-paying blue chip stocks. There are a variety of bond funds, as well. Municipal bond funds provide shareholders with tax-advantaged income. Others specialize in U.S. government bonds.
Money Market Income Funds are designed to provide the investor with income as well as with high stability of principal (though generally no capital appreciation) by investing exclusively in short-term debt securities issued by banks, corporations, and the U.S. Treasury (and U.S. government-sponsored enterprises such as Ginnie Mae, Fannie Mae, and Freddie Mac).Some funds, even more conservative, invest strictly in securities whose timely payment of interest and principal is guaranteed by the full faith and credit of the U.S. government. Municipal bond money market funds specialize in investing in short-term, high-rated municipal debt securities in order to provide their shareholders with tax advantages.
International and Global Funds involve an added element of risk since they invest all over the world. Such funds involve added risks associated with currency fluctuations and economic and political instability. International funds generally seek growth through investments in companies outside the United States. Global funds seek growth by investing in securities around the world, including in the United States.International mutual funds are an excellent way to invest abroad because an individual American investor may be unfamiliar with foreign investment practices and currencies and may not have a clear understanding of economic or political events that can affect foreign securities. Some of these funds concentrate on a particular country, while others on a specific region of the world. Funds in these two categories are generally growth or aggressive growth funds.
Unit Investment Trust
What is a Unit Investment Trust?
A Unit Investment Trust (UIT) holds a fixed portfolio of securities, most often comprised of tax-exempt municipal bonds but also commonly consisting of government bonds, corporate bonds, mortgage-backed securities or common stocks. Unlike mutual funds, where securities are bought and sold as the portfolio manager deems appropriate considering the current market environment, the securities in a UIT are not actively managed. A UIT is sponsored by a securities firm or group of firms. The sponsor assembles a portfolio of stocks or bonds that remains unchanged for the life of the trust, which may run from 6 months to 30 years. Investors purchase trust units which represent ownership in the trust portfolio and an opportunity to share in the UIT's income and capital gains and appreciation, if any.
Interest payments from bonds in a bond trust are distributed on a regular basis to investors in the trust, and each time a bond in the trust matures, the repaid principal is distributed to trust investors. When the last bond matures, the trust is liquidated.
Similarly, dividend payments from stocks in a stock trust are distributed to investors on a regular basis. At the end of a specified period (set when the trust was created), the stocks are sold at that day's market price, the proceeds from the sale are distributed to investors, and the trust is liquidated.
