 Personal Finance PowerPoint Presentation, Mutual Fund Part 2. Prepare to get financially fit by practicing personal finance. Most of this information can be found at Investopedia Mutual Funds, which you can find online. Take a look at the references, resources, continue your research from there. This by Adam Hayes updated March 7th, 2022. In prior presentations, we've been taking a look at investment goals, investment strategies, what corporations are, and then discussing and starting to discuss what mutual funds are. Quick recap here. Corporations are going to be separate legal entities. So we as human beings gave basically corporations rights that we typically think of as human rights from a natural rights perspective, such as the right to own property, allowing us as shareholders to own shares then of the corporation of this separate legal entity. From an investment perspective, oftentimes we think of that corporation being on an exchange. Larger corporations often participating in being on exchanges so that they can try to generate more capital to be on the exchange. The exchange usually requires that a corporation show some transparency and the way they're going to report the information so that investors have that transparency and that dependability that trust in order to invest in the corporations that are on, say, the exchanges. However, individual investors then still have an issue or a problem investing in individual stocks because it's difficult to have a diversified portfolio when you have to invest basically in the stocks individually that can be costly as well. So then the concept of mutual funds comes into play where basically investors can put money into a pooled fund for the mutual fund and then the mutual fund has promised to make an allocation between financial investments, typically stocks, but stocks and bonds, for example, other types of financial investments according to the terms of the mutual fund, allowing investors then to have the ability to have a diversified portfolio even if they have a fairly small amount of investments. That's where we went last time. Now we're continuing on with the concept of the mutual fund. So now we've got the fixed income funds. So we're talking about different types of mutual funds. Now note, we might talk more about this in the future, but just realize when we get down into the weeds, it could be a little bit more overwhelming to think about all the different kinds of mutual funds. In other words, if you think about stocks in and of themselves, even stocks that are just publicly traded stocks that are on the exchanges, clearly that's a whole lot of stuff that can be overwhelming. So we can start to categorize these stocks and think about them in categories. And that's what we do when we think about indexes and averages and so on. And then when we get into the mutual funds, even just looking at mutual funds, which is now a pooling of stocks, there's still like an endless amount of ways you can pool stocks. You can think of infinite ways to basically pool stocks together in different ways. But so then we want to take these concepts into consideration in alignment with our overall investment strategy and our goals and our time horizons. For example, we might from a more basic kind of strategy use a mutual fund that has a targeted index fund that basically has a different mix that is accordance to our time horizon. And that's one way that we can really kind of simplify things if you want kind of a basic approach to still get a diversified portfolio. People will argue whether that's the best or ideal strategy or not. Obviously, no matter what you do, people will argue with it because everybody's going to have their own opinion about it. Or you can take a look at different kinds of mutual funds in order to diversify. Looking at mutual funds that have different mixes that you think fit best into your portfolio. So another big group is the fixed income category. A fixed income mutual fund focuses on investments that pay a set rate of return, such as government bonds, corporate bonds or other debt instruments. The idea is that the fund portfolio generates interest income, which is then passed to the shareholders. So if they're investing, if you have a fund that's investing in the bonds, and therefore they're investing in types of investments that have set types of returns like interest for the bonds, then that's a way to get some interest on it. And that's something that you might be looking for possibly towards the end, like at retirement, for example, when maybe you want that income to be living on the income as opposed to when you're in the younger years where you might be investing in things more so, where they're going to reinvest in looking for the value of the stock to go up, not looking so much to be living on the income from it. So sometimes referred to as bond funds, these funds are often actively managed and seek to buy relatively undervalued bonds in order to sell them at a profit. So these mutual funds are likely to pay higher returns than certificates of deposit and money market investment, but bond funds aren't without risk. So note that when you're thinking about bonds, sometimes like if you're thinking about really kind of secure bonds, it could seem like a little bit more boring when you have a bull market or a market that's going well because the equities could have that potential for the greater growth. But obviously they also have the potential to fall. So if you go into like a downturn, the bonds could be a safeguard. Notice that historically, from this point, we've had historically low rates for quite some time. So you might look at the bonds and the other types of investments that have interest like certificates of deposits and savings accounts and whatnot and say, wow, I'm getting like nothing in terms of returns, but the inflation rate and the interest rates, inflation has also been low as well. So if things change and we have a period of a downturn in the market or higher inflation, then of course these funds that pay interest, for example, look more appealing or you could see the return on them. But because there are many different types of bonds, bond funds can vary dramatically depending on where they invest. For example, a fund specializing in high yield junk bonds is much riskier than a fund that invests in government securities. So we don't want to think just basically the idea that bonds are going to be just safe in and of themselves. If you go into the world of bonds, there's a whole lot of different kind of bonds that you can go into. Most of the time when people think of bonds, they're thinking about bonds for like big corporate. If you're just a general investor, you might have like large corporate bonds and then you might have to have like government bonds like treasury bills and whatnot. And those are generally thought of to be quite secure. But if you get into like junk bonds, then you've got a more risk scenario as well. And usually you're talking to people that are more skilled investors that are trying to invest in that area there. So the average investor might not be in junk bonds as often. So furthermore, nearly all bond funds are subject to interest rate risk, which means that if rates go up, the value of the fund goes down. So clearly if the bonds are locked into these term bonds that are investing that are getting interest, if interest rates go up, then the bonds that are in the funds have these locked rates. And so that would mean that would be bad for the holdings of the bonds making the price go down. So index funds. So this is another key group, which I think is really important to be aware of because now we've got the idea of investing in stocks and bonds. We've got the idea of mutual funds, which might have a manager, but then you're looking index funds. Now the index funds are really nice because you would think it would take less of basically a manager that's kind of picking and choosing individual stocks. You're taking that out of the hands of the manager and saying just basically tie it to some kind of index. Index is being something that we often look at just to value the market basically in general to see if the market's going up or down. We try to get a pool of certain stocks that represents a certain segment of the market and then use that. And so instead of giving the leeway to a professional to do whatever they want or have more leeway to do what they want, you might just say, hey, just tie it to the index and then you would think that would take less management time or decision-making and cost you less in that way. So another group, which has become extremely popular in the last few years, falls under the moniker, quote, index funds, end quote. Their investment strategy is based on the belief that it is very hard and often expensive to try to meet the market consistently. So in other words, if you're with an investor, even professional investors, they might have a good track record for a while, but then you really don't know how good their track record is until you look at it after they're done to see what their average was over the full time frame. So a lot of times a lot of people argue you might be better off just picking the indexes that are geared to give you the average of different sectors of the market instead of betting on an individual or a company that thinks that they can beat the averages of the market. That's a huge debate that you're going to see when you look at stock channels that are played on TV. Obviously, half the people that they're investing are professional paid investors that they would have the perspective, I can beat the market. That's what you're being paid to do. And other people are going to say, well, I don't know if you can. Let's take a look at your track record. And again, everybody might have a good track record when times are good, right? You got to take a look at the track record over a fairly extended period of time to see if someone has actually proven that they have a return over and above the market and so on. So the index fund manager buys stocks that correspond with a major market index such as the S&P 500 or the Dow Jones Industrial Average. So these strategies requires less research from analysts and advisors. So there are fewer expenses to eat up returns before they are passed to the shareholders. So in other words, you're not doing the stock picking at this time. You're not trying to beat the market. You're just tying it to the index. So we shouldn't have to be paying as much to do that. So these funds are often designed with cost-sensitive investors in mind. Balance funds invest in a hybrid of asset classes, whether stock, bonds, money market instruments, or alternative investments. So now we're looking at indexes or funds that aren't just invested in stocks or just bonds, for example, but they have a hybrid. So now they're trying to balance across multiple investment types. So the objective is to reduce the risk of exposure across asset classes. This kind of fund is also known as asset allocation fund. There are two variations of such funds designed to cater to investors' objectives. Some funds are defined with a specific allocation strategy that is fixed so the investor can have a predictable exposure to various asset classes. So they might say, hey, look, I'm going to try to invest so much in stocks, bonds, and so on. And I'm going to keep that the same. Other funds allow a strategy for dynamic allocation percentages to meet various investor objectives. These may include responding to market conditions, business cycle changes, or changing phases of the investor's own life. So the most common one there might be the one that for most individuals, you might be looking at the one that's going to change with your own life. So meaning your retirement age is coming up. So typically you might choose one fund now. And this would be the most simplified type of thing to try to get an investor that wants to just invest in a diversified portfolio without getting way too complicated at it. They might just say, I'm going to look for a fund that has an appropriate mix. And this, of course, would be according to the fund, right? It has an appropriate mix according to my expectations in terms of when I'm going to basically reach retirement and then it will shift as I get closer to retirement, hopefully doing so in such a way that it's an optimal mix for my age and how close I am to retirement. So that's one way, you know, you can kind of simplify things and still hopefully be basically diversified and try to say, I'm just going to put my money all in that one place. If you have multiple different, you might try to expand your strategy by having index funds that have different fixed mixes, and then you can try to invest in the index funds as you get closer to retirement in such a way and adjust your own mix that you think is most appropriate given your age and time frame and time horizons. That gets, of course, a little bit more complicated. If you use tools online these days, like the Personal Capital Tool, they could try to take some of these funds that are grouped together and show you what your overall asset allocation is, which might help you to do your own kind of asset allocation which you and customize it a bit more. Obviously, if you use a target fund, then you're kind of dependent on whatever the target fund thinks is the ideal asset allocation, which you may or may not completely agree with. There could be some leeway with it, but an engineer. While the objectives are similar to those of a balanced fund, dynamic allocation funds do not have to hold a specific percentage of any asset class. So the portfolio manager is therefore given freedom to switch ratio of asset classes as needed to maintain the integrity of the funds stated strategy. Now, notice as you give the fund manager more freedom to do things, then you're taking out a little bit more risk because now that depends on the quality of the fund manager depending on what kind of freedom they have. And so it might cost more to do that, of course, because now they're making their own decisions as opposed to just tying it to an index fund. So money market funds. The money market consists of safe, risk-free, short-term debt instruments, mostly government treasury bills. So this is a safe place to park your money. So you're not going to see a lot of, you would think, you wouldn't see a lot of ups and downs on this one as you would in like equity funds. And so it's a little boring to look at them and when the market's doing good, you're going to go, man, this is why I'm not even getting my inflation. I'm not even covering, but when the market goes down and you're getting killed on your equity investments, you can at least say, well, at least the money market funds are not, so that's why you want the diversification. So you won't get substantial returns, but you won't have to worry about losing your principal. A typical return is a little more than the amount you would earn in a regular checking or saving account and a little less than the average certificate of deposit. Again, you might be saying, hey, I earn almost nothing in my checking or savings account, even the certificate of deposit at this point in time. And that's because the interest rates have been kind of historically low for a long time, but if we hit a period of inflation, then you're going to see interest is going to be playing, you know, a bigger factor if that takes place. So while money market funds invest in ultra safe assets during the 2008 financial crisis, some money market funds did experience these losses after the share price of these funds typically pegged to a dollar fell below the level and broke the buck. But income funds, so income funds are named for their purpose to provide current income on the steady basis. These funds invest primarily in government and high quality corporate debt holding these bonds until maturity in order to provide interest streams. So notice that you might then be investing typically later on in life. So now you're in retirement possibly and you're living off your investments. You're saying, I got my money in my investments. I got my money off the earnings of that money. Therefore, I can't invest all my money, perhaps, in things that are still growing because they are not going to pay dividends if I put my money into growth stocks. Those stocks are putting the money back into the company hoping to increase the share price as opposed to giving dividends. And so rather I need to put my money in types of investments that give me a return like interest and dividends that I live on. While funds holdings may appreciate and value the primary objective of these funds is to provide steady cash flow to investors. As such, the audience for these funds consists of conservative investors and retirees. Because they produce regular income, tax-conscious investors may want to avoid these funds. So in other words, the interest that you're getting, dividends, and if you get dividends and interest, for example, there could trigger tax consequences for it. So if on the other hand, you're investing in companies that reinvest the dividends and interest, then you're getting an increase in the value of the stock which should increase your stock price. And you might think, well, isn't there a tax consequence on that? There will be when you sell the stock, but you get to defer the tax consequence and have some control over when it will happen by determining when you sell the stock. And then you'll have capital gains. So international global funds and international fund or foreign fund invest only in assets located outside your home country. Global funds, meanwhile, can invest anywhere around the world including within your home country. So now you might start thinking, I would like to get some exposure to places outside of the United States, if you're in the United States or wherever your country is. But if you're in the United States, you might say, I want access to funds that are outside of the United States specifically. And you can try to determine what percentage you would want outside. So if you have all of your holdings within the United States, you might then pick a fund that has withholding specifically outside of the United States in some way to get that kind of diversity. Or you might try to pick a fund in general that has a mix most likely weighted heavily in the US and then have some outside. And again, why would you want US stocks and outside stocks? One of the reasons a lot of the capital comes into the US is not because the potential for growth is the maximum potential. You would think just like with small companies, you would think the biggest potential for growth would be the countries that are catching up in terms of industrialization and whatnot because they have the biggest growth potential. But they don't have as much transparency and so on and they might not do well in the short term and so on. Whereas in the US, we're kind of like the company already at the top like the electric company like an Edison or something like that. You wouldn't expect growth to jump up possibly all the time. But you might say that there's good transparency in the markets and the exchanges are quite transparent and so on. So you kind of have trust in the returns which is one of the reasons we're able to kind of draw in a significant amount of capital. One of the reasons you want a significant amount in trustworthy exchanges and so on. So in any case, it's tough to classify these funds as either riskier or safer than domestic investments but they have tended to be more volatile and have unique count country and political risks. So obviously the risks in other countries are going to be different and diverse, possibly larger, but again, you might have exposure to larger gains and you might have some diversification that could be useful because of some parts of the country go down and you have some diversification other parts of the country then that could give you that same kind of protection possibly as other types of diversity does. So on the flip side, they can as part of a well-balanced portfolio actually reduce risk by increasing diversification since the returns in foreign countries may be uncorrelated with returns at home. So although the world's economies are becoming more interrelated, it is still likely that another economy somewhere is outperforming the economy of your home country. So in other words, you would think that there's interdependence on a lot of the world stage these days but again, at this point in time, it looks like the supply change and so on are going in reverse at a less global economy kind of thing and people are kind of being a little bit more self-independent at this point, so interesting dynamics. Specialty funds, this classification of mutual funds is more for an all-encompassing category that consists of funds that have provided that have proved to be popular but don't necessarily belong to the more rigid categories we've described so far. These types of mutual funds for go-broad diversification to concentrate on a certain segment of the economy or targeted strategy. Sector funds are targeted strategy funds aimed at specific sectors of the economy such as financial, technology, health, or so on. So now you're looking at the funds by sector. So sector funds can therefore be extremely volatile since the stocks in a given sector tend to be highly correlated with each other. There is a greater possibility for large gains but a sector may also collapse for example, the financial sector in 2008 and 2009. So if you're investing by sector you probably might have your own diversification strategy so you're trying to say I'm going to invest in these different sectors specifically possibly as part of your own diversification strategy you probably wouldn't want to invest all your money in one particular sector because although you're somewhat diversified within the sector if something happens for that entire sector like the financial sectors went down after 2008 then you're exposed to that downturn. Make it easier to focus on special geographic area in the world this can mean focusing on broader region say Latin America or on individual country for example only Brazil and advantage of these funds is that they make it easier to buy stock in foreign countries which can otherwise be difficult and expensive just like for sector funds you have to accept the high risk of loss which occurs if region goes to a bad recession. So socially responsible funds or ethical funds invest only in companies that meet the criteria of certain guidelines or beliefs for example some socially responsible funds do not invest in sin industries such as tobacco alcohol beverages weapons or nuclear power. So these have kind of been more popular in the current in the current time series to say well what is the company actually investing in? I don't want my mutual fund to be investing in things that I personally don't like and so you could try to and if you just invested in a mutual fund that can be kind of difficult to do because again the mutual funds can be investing you might give them leeway to invest in whatever they want you might look at it and say they're investing in some stuff that I don't think is a beneficial thing to do so you could start looking into that in terms of setting your investment goals as well. The idea is to get competitive performance while still maintaining a healthy conscience other such fund invests primarily in green technology such as solar and wind power or recycling. So exchange traded funds the ETFs a twist on the mutual fund is the exchange traded fund the ETF these ever more popular investment vehicles pool investment employee strategies consistent with mutual funds but they are structured as investment trusts that are traded on stock exchanges and have the added benefit of the features of stock. So for example ETFs can be bought and sold at any point throughout the trading day ETFs can also be sold short or purchased on margin ETFs also typically carry lower fees than the equivalent mutual fund many ETFs also benefit from active option markets where investors can hedge or leverage their position. ETFs also enjoy tax advantages from mutual funds compared to mutual funds ETFs tend to be more cost effective and more liquid. The popularity of ETFs speaks to their versatility and convenience so notice a lot of these kind of activities here are geared possibly towards people that are doing more active kind of trading so some of those kind of things if you're in the market for the long term might not be things that are going to sway your opinion between the ETFs and the mutual funds if you're doing more active day to day types of trading trading kind of on the short term then you got some more some of those components might be more appealing. So mutual fund fees and mutual fund will classify expenses into either annual operating fees or shareholder fees are an annual percent of the funds under management usually ranging from 1 to 3 percent so the fees are going to be an important thing to be comparing when you're looking at different investment options annual operating fees are collectively known as expense ratio a funds expense ratio is the summation of the advisory or management fee and its administrative costs so shareholder fees which come in the form of sales charges commissions redemption fees are paid directly by investors when purchasing or selling the funds sales charges or commissions are known as quote the load or of a mutual fund when a mutual fund has a front end load fees are assessed when shares are purchased for a back end load mutual fund fees are assessed when an investor sells his shares sometimes however the investment company offers a no load mutual fund which doesn't carry any commission or sales charge these funds are distributed directly by an investment company rather than through a secondary market some funds also charge fees and penalties for early withdrawal or selling the holding before a specific time has elapsed also the rise of exchange traded funds which have much lower fees thanks to their passive management structure have been giving mutual funds considerable competition for investors dollars articles from financial media outlets regarding how fund expense ratios and fluids can eat into rates of returns have also stirred negative feelings about mutual funds