 Personal Finance PowerPoint Presentation. Mutual Fund Part 1. Prepare to get financially fit by practicing personal finance. Most of this information can be found at Investopedia Mutual Fund, which you can find online. Take a look at the references, resources, continue your research from there. This is by Adam Hayes, updated March 7th, 2022. In prior presentations, we've been taking a look at investment goals, investment strategies. We talked about what stocks were and now we're thinking about the question, what is a mutual fund? A mutual fund is a type of financial vehicle made up of a pool of money collected from many investors to invest in securities like stock, bonds, money market instruments and other assets. So let's give a quick recap of where we have been. Note that we think about a corporation in general that was a huge invention or innovation, where we from basically a natural rights kind of perspective took human rights, gave it in essence to a corporation so the corporation can now own property. When the corporation can own property, then of course they want to possibly generate capital within the corporation so the corporation can basically grow for the benefit of the owners of the corporations, which are the stockholders. We then could think about the stockholders or the corporation then trading their stocks on a public exchange, a public exchange having regulatory policies so that the trading of the stock or the corporation is as transparent as possible in terms of rules for reporting their financial statements and so on so that investors have an idea of what they're investing in and all the shares then we have the concept of the shares being the same. So the same kind of ownership for common stock ownership in a corporation given every shareholder the same thing for each individual share of common stock, which makes it easier for us to value what the common stocks are. So that's usually what we think of as purchasing on an exchange when we're purchasing the common stock. Now the problem with that then was that people that are wealthy could purchase different individual common stocks and have a portfolio. However, it can be expensive to purchase individual common stocks and therefore the people that don't have as much money are not going to have as much access to the market in that way and have much less capacity to have a diversified portfolio. So then we have the concept of well, what if we have multiple people that can pool the money into a mutual fund and they can put small amounts of money into the mutual fund but still be allowed to have diversity because that pooled money can now be invested in different assets, typical assets, often the first people think people think of being the stocks. So now we can say, okay, now I have a diverse more diverse portfolio, even though I put a fairly low amount of money in which I could not do if I was to purchase the individual stocks because of the tools of the mutual funds. And then of course we can diversify across the different types of financial instruments in a mutual fund. Once the funds are pooled together, stocks, bonds, money market instruments and so on. So when we think about investing typically into a 401k, an IRA or just us participating, a normal person participating in the stock market, we're usually thinking about tools like mutual funds, tools which pool together your money and other people's money and then put the investment in place in accordance with whatever rules of the mutual fund have been set up. And then your whatever rules have been set up for your benefits will then be in that format. So huge tool, huge benefit to individual investors as well as of course corporations because the investors now have the capacity to invest and the corporations have a desire to be as transparent as possible to participate in the stock exchange even though they have to go through all these rules to show their transparency in a fair way that would be the idea because they want to generate capital. They want people to invest in the corporation so it should be good for everybody involved. So mutual funds are operated by professional money managers who allocate the funds assets and attempt to produce capital gains or income for the funds investors and mutual funds portfolio is structured and maintained to match the investment objectives stated in its perspectives. Mutual funds give small or individuals investors access to professionally managed portfolios of equities bonds other securities. Now when we start thinking about this pool together money then the question comes up well should I have should I have a type of mutual fund that's going to take a lot of managing costs do I want to be more dependent on the people managing the mutual fund or possibly do I want to try to tie my mutual fund to something like an index where you basically kind of trying to get an average of the market type of type of thing obviously more management that you have in the mutual fund the more leeway you give to to manage to the manage of the fund the more cost you will have because of course you'll be paying the fund manager to manage so there's always the question of is it worthwhile to pay a fund manager or that we're hoping can beat the market in essence or should we just be investing in things that are tied to say index funds or something like that where we're just betting on in essence markets or segments of the markets so each shareholder therefore participates proportionately in the gains or losses of the fund so mutual funds invest in a vast number of securities and performance is usually tracked as the change in the total market cap of the fund derived by the aggregating performance of the underlying investments so understanding mutual funds mutual funds pool money from the investing public and use that money to buy other securities usually stocks and bonds so the value of the mutual fund company depends on the performance of the securities it decides to buy so when you buy a unit or share of a mutual fund you are buying the performance of its portfolio or more precisely a part of the portfolios value so obviously again that you're buying into a portfolio that you couldn't afford to diversify in that way most likely and that's what the exposure you're looking to get so investing in a share of a mutual fund is different from investing in shares of stock so then the underlying investments of the mutual fund may then be stocks at least in part but you're not investing in the stock directly you're investing in the mutual fund so unlike stock mutual funds shares do not give its holders any voting rights so note the voting rights and for a lot of people that if you're not involved in the day-to-day operations of the companies that might not be a big thing to you because if you own one share of like Apple then you're probably not tracking the ins and outs of the board of directors and management of Apple as closely as if you had a more significant rule but it could that could be you know a significant component depending on what your objectives are a share of a mutual fund represents investments in many different stocks or other securities instead of just one holding that's why the price of a mutual fund share is referred to as the net asset value the NAV per share sometimes expressed as NAV PS a funds in a V is derived by dividing the total value of the securities in the portfolio by the total amount of shares outstanding outstanding shares are those held by the shareholders institutional investors and company officers or insiders mutual fund shares can typically be purchased or redeemed as needed at the funds current in a V which unlike a stock price doesn't fluctuate during market hours but it is settled at the end of each trading day so clearly you know if they're based on a portfolio then the portfolio they might not be adjusting they're not going to adjust the portfolio necessarily real time right they're going to adjust it on a periodic basis ergo the price of a mutual fund is also updated when the NAV P is settled the average mutual fund holder holds over a hundred different securities which means mutual funds shareholders gain important diversification at a low price that's the point for most people they want to have a diversification exposure to different stocks and so on to get that diversified portfolio which they couldn't get generally by investing at one stock at a time because it would be more costly to do so and complicated typically consider an investor who buys only Google stock before the company has a bad quarter they stand to lose a great deal of value because all of their dollars are tied in one company so that would be undiversified all your money is in one company on the other hand a different investor may buy shares of a mutual fund that happens to own some Google stock when Google has a bad quarter they lose significantly less because Google is just a small part of the funds portfolio now you might be saying well what if Google jumps up in value and now I've deluded my earnings I could have earned a whole lot more if I had all my money in Google notice that that's more of a gambling type of thing unless you have unless you've really looked at it and you've said I think that Google is undervalued for this reason and that reason I'm going to invest in it particularly but if you're just investing in individual stocks without having some kind of in-depth understanding of them then that seems to be more kind of like gambling right if you're in that area then you probably want to have a more diversified approach would be your general idea and if you want to have some money to basically gamble with on the stock market if you're not and then you might want to make sure that you have money that you can stand to lose in order to do that unless you're again spending a whole lot of time researching the individual stocks and have a theory as to why you're going to be waiting individual stocks separately and not having the normal kind of diversification idea that most people would suggest for general investors so how mutual funds work and mutual fund is both an investment and actual company so this dual nature may seem strange but it is no different from how a share of a a p l is a representation of apple incorporated when an investor buys apple stock he is buying partial ownership of the company and its assets similarly a mutual fund investor is buying partial ownership of the mutual fund company and its assets the difference is that apple is in the business of making innovative devices and tablets while a mutual fund company is in the business of making investments investors typically earn a return from a mutual fund in three ways number one income is earned from the dividends on stocks and interest on the bonds held in the funds portfolio just like if you were to invest in stocks you might get dividends and you might have a gain in the value of the stock if you're invested in bonds then you're typically going to be getting interest on the bonds a fund pays out nearly all the income it receives over the year to fund owners in the form of distribution funds often give investors a choice either to receive a check for distributions or to reinvest the earnings and get more shares too if the funds sell securities that have increased in price the fund has a capital gain so if the value of the company goes up and you sell it or the fund does right then you're going to get a capital gain most phones also pass these gains to investors in distributions number three if funds holding increase in price but are not sold by the fund manager the funds shares increase in price so if they don't sell the funds then they have unrealized capital gains which often is you know that's an increase in value that hasn't been realized so you can then sell your mutual fund shares for a profit in the market so you could sell your actual shares in the mutual fund if they have going up in price in that case so generally if you have a mutual fund you're going to be getting possibly the returns that flow through the mutual fund of the dividends for the investments that are in stocks that pay dividends and interest for the investments that are in bonds that will flow through to you if the mutual fund sells the stocks within the mutual fund then they will incur capital gains if they were the gain on it that might pass through to you and then if you actually if you then sell your mutual fund if it had increased in price then you would have the capital gain at the sale in a similar way that you would if you owned an individual stock that had increased in price so if a mutual fund is constructed as a vertical company its CEO is the fund manager sometimes called its investment advisor the fund manager is hired by a board of directors and is legally obligated to work in the best interest of the mutual fund shareholders so you've got that agency kind of thing going on here most fund managers are also owners of the fund there are very few other employees in a mutual fund company the investment advisor or fund manager may employ some analysis to help pick investments or perform market research a fund accountant is kept on staff to calculate the funds in a v the daily value of the portfolio that determines if share prices go up or down mutual funds need to have a compliance officer or two and probably an attorney to keep up with government regulations most mutual funds are part of a much larger investment company the biggest have hundreds of separate mutual funds some of these fund companies are name are names familiar to general public such as Fidelity Investments the Vanguard Group T-Raw Price and Oppenheimer types of mutual funds mutual funds are divided into several kinds of categories representing the kinds of securities they have targeted for their portfolios and the type of returns they seek so now that we have the mutual funds now we've got this grouping and we've got to think okay what are my investment goals what's my investment strategies what kind of mutual funds can i invest in basically to meet these goals and strategies and again there's a whole array of mutual funds we want to be considering how much leeway the the mutual fund managers have on it or do we want to have more less management fund what's going to be the cost of their that and then is the and then we want to consider of course like the mix so there is a fund for nearly every type of investor or investment approach so other common types of mutual funds include money market funds sector funds alternative funds smart beta funds target target date funds and even funds of funds or mutual funds that buy shares of other mutual funds so equity funds the largest category is that of equity or stock funds this would kind of make sense because this is kind of the original idea you would think that individuals investors wanted exposure to stocks but didn't want to have to buy the individual stocks or it's quite expensive to do so to do diversify so as the name implies the sort of funds invests principally in stocks within this group of various sub categories some equity funds are named for the size of the companies they invest in so you got small mid or large so we might try to concentrate on the size of the company obviously the smaller companies are usually more risky because we're hoping they're going to grow more and so the large cap companies are large because they've hit that point where they're basically hopefully stable and just plowing along at that point so others are named by the investment approach aggressive growth income oriented value and others equity funds are also categorized by whether they invest in domestic us stocks or foreign equities there are so 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 so the idea here is to classify funds based on both the size of the companies invested in their market caps and the growth prospects of the invested stocks the term value fund refers to a style of investing that looks for high quality low growth companies that are out of favor with the market these companies are characterized by low price to earnings PE ratios low price to book PB ratios and high dividend yields conversely spectrums are growth funds which look at companies that have had and are expected to have strong growth in earnings sales and cash flows these companies typically have high PE ratios and do not pay dividends a compromise between strict value and growth investment is a blend which simply refers to companies that are neither value nor growth stocks and are classified as being somewhere in the middle so you've got your box here that you could try to categorize in many like if you look at like the the the investment companies online like a vanguard or something like that you'll often see a a kind of box like this dot give you a pictorial way or an overview of the the fund characteristics so so the other dimension of the style box has to do with the size of the company that a mutual fund invests in large cap companies have high market capitalizations with values of ten billion dollars so market cap is derived by multiplying the share price by the number of shares outstanding large cap stocks are typically blue chip firms that are often recognized by name small cap stocks refer to those stocks with a market cap ranging from 250 million to 2 billion these smaller companies tend to be newer riskier investment mid cap stocks fill in the gap between small and large cap a mutual fund may blend its strategy between investment style and company size for example a large cap value fund would look to to large cap companies that are in strong financial shape but have recently seen their share price fall and would be placed in the upper left quarter of the style box large and value so the opposite of this would be a fund that invests and start at technology companies with excellent growth prospects small cap growth such as mutual fund should reside in the bottom right quadrant small and growth so we might dig into this in a little bit more detail in future presentations the general idea we want to take away from here is that you know the mutual funds can be a great tool for us to diversify basically being able to invest in the standard kind of things that we would think of when we think of investing oftentimes being the bonds and the stocks but do so in a way that we can pool the resources together and be able to find diversification in that way and then obviously we can dig into the weeds in terms of what are the best diversification ideas for our particular situation which gets back into our investment goals and our investment strategies unique to us