Saturday, September 20, 2008
Various Investment Strategies
| Although the goal of this web page is not to proffer free advice on investing per se, there are some basic tenets and principles that any judicious investor should follow. A lot of it may seem to be obvious to most, but surprisingly enough, many people hardly adhere to what is deemed as "common sense." The smart investor is definitely one who is aware not only of the complete composition of the his/her portfolio, but also of market trends. These factors enable the investor to make an informed decision--and an informed decision is 90% of the work towards successful investing. There are several techniques used by many investors while tracking their mutual funds. The "momentum strategy" is the buying of stocks of companies whose earnings are rising. You may be wondering why anybody would buy the stocks of companies whose prices were not rising. But there is another strategy of buying the stocks of undervalued companies. This strategy "bets" that the prices of these companies are bound to rise, and with time, will do so. There is, of course, the traditional strategy of buying the mutual funds of blue-chip stocks. But, as expected, many investors buy into the mutual funds of small companies. Diversification is very important when practicing this strategy. Many investors also follow the "buy and hold" strategy. This is for the long-term investor who doesn't believe that the market changes greatly day-to-day. The momentum investors believe that buying-and-holding is too broad and non-responsive to the dynamics of the market. Important Available Resources Okay, we've thrown a lot of information your way. Do you still have many questions? Are there still uncertainties in your mind about certain things? Well, fortunately, there are several excellent guides and resources available for people to learn more about the world of mutual funds. * No-Load Fund Investor. This is monthly publication that gives investors information on 664 no-load and low-load funds. It contains information on returns, risk, asset size, and gives diversification suggestions. The No-Load Fund Investor, Inc. P.O. Box 283 Hastings-on-Hudson, NY 10706 (800) 252-2042 * Mutual Fund Buyer's Guide. This is a fairly inexpensive monthly publication that provides similar information as the No-Load Fund Investor and covers over 1500 funds. The Institute for Econometric Research 3471 N. Federal Fort Lauderdale, FL 33306 (800) 442-9000 * Morningstar Mutual Funds. This is an excellent detailed source of information on mutual funds. Over 1240 funds are followed and profiled regularly. Closed-end funds are also followed in a newsletter that is published. Morningstar also does corporate and private research on particular funds, charging fees for their services. Morningstar 53 West Jackson Blvd. Chicago, IL 60604 (800) 876-5005 The Wall Street Journal and Investor's Business Daily are two other thorough resources that you may want to consider reading |
The Importance of Diversification
| We cannot overemphasize the importance of having a well balanced and diversified mutual fund portfolio. But what does this exactly mean? A total investment of between $5000 and $6000 could make your portfolio fairly diversified. Even the mutual funds themselves can be diversified in a variety of investments. The mutual funds that are better diversified tend to do better than the non-diversified funds. The same is true with your overall portfolio. In short, diversification provides insurance. Generally, mutual fund investors tend to be conservative as the graph below illustrates. But they do vary the types of invesments that they are involved with at different times in life. |
Choosing the Right Fund
| One of the key ways to choose a fund is to evaluate its past performance. This is one of the integral characteristics of the successful investor that was described at the beginning of this section. By tracking how profitable a fund has been, you will gain a feel for the fund. Like stocks, mutual funds have their own "personality." Knowing this personality will help even the novice investor make decisions that are more intuitive and well-informed. There is the commonly held belief by many investors that certain funds do better or worse than others because they briefly outperform or underperform the averages. This is thought to be only temporary. In the end, funds are supposed to revert back to the normal middle ground. If one looks at the performance of funds over time, it is true that most funds do become average performers. Nevertheless, look for the some of the following indications when choosing a fund: * The fund has outperformed similar funds. * Over the years, despite occasionally "off-years," the fund has made huge profits. * The fund consistently has made a profit. * The fund has outperformed some of the major indexes (i.e. Dow Jones, S&P 500, etc.) Granted, some of these criteria may appear to be common sense, but you would be surprised how many advisers do not follow this. Often times, people plunge into a mutual fund, stock or some investment based on a "hot tip" or a "hunch." It is imperative that you know a fund well and can provide reasons for investing in it before you actually do so. |
The Prospectus
| A mutual fund has to send you a report called a prospectus in order to sell you anything. The prospectus tells you all about the fund that you have interest in--from its primary investment objective, to sales and redemption charges, all fees involved, minimum investments, address, phone number and a lot more. The prospectus can be quite tedious and boring, but is very important for the serious investor. He/She knows a fund well before investing money into it. The most important aspects to pay attention to in the prospectus are: Date of issuance, minimum investment, objective, record of performance, degree of risk and fees. If you can't make it through the entire prospectus, get a hold of these books: Mutual Fund Sourcebook and The Handbook for No-Load Fund Investors. They will give you the important information that you need, including some that is missing from prospectuses (i.e. volatility, who the portfolio manager is, etc.). Yields As the prices of the individual components of the mutual fund you have invested in fluctuate, so will the price of the fund itself. Thus, the yield that a mutual fund is earning you is constantly changing. This is different than the constant yield you would get with a CD. Figuring out yield can be confusing, but take it slowly and you will be able to do it. This is the way that it is done: * Add all income distributions (dividends, interests, or both) for the past 12 months. * Divide by the current NAV (minus capital gains distributions). Capital gains are not a part of the yield you earn because they cannot be exactly quantified--they vary depending upon the state of the market. Instead, they are a part of the total return--yield plus gains or losses on the principle. Many investors are deceived by the tricky nature of yields. A stock's yield depends on both the price per share and the regular dividend that the stock issues. If you have a stock with a NAV of $25, and a dividend of $2, the yield is 8%. (2 divided by 25 = 0.08, see the two steps above) If the price goes down to $20, the yield would rise to 10%. (2 divided by 20 = 0.10) Even though your yield went up percentage wise, the overall stock price is down 20%. But you must understand that yields are a highly personal thing. Yields published in a newspaper are irrelevant to you if you did not invest on the date that the yield is based on. If you are not invested in anything and are simply comparing different funds' yields, then this information can be useful. Otherwise, you must refer to the date and amount of your investment for yield to have any meaning. Dollar-Cost Averaging Dollar-cost averaging is an important concept that investors should learn. When you utilize this technique, you are diversifying the prices at which you buy an investment over a period of time. As a result, you end up paying lower than average prices. Thus, you have "averaged" the "dollar-cost" at which purchased a fund. This technique will prevent a major disaster from taking place, but at the same time, it will limit the profits that you reap, as well. If the prices had gone up during the entire year, dollar-cost averaging would have proved detrimental. At the same time, if prices had plummeted the whole year, the average cost of what you paid would have been lower than it could have been. Market Timing As anyone who has any experience in investing can tell you, the market is very dynamic and in a constant state of flux. Knowing the nuances of the market takes years of experience, but keeping a close eye on major trends will be helpful to any investor. But you do not need to be an expert, sophisticated investor to spot the obvious signs. When the market is reaching all-time highs, it is usually time to lighten up on your investments. When the market is unusually low, it is an opportune time to buy. This is a mild version of market timing. Market timing is knowing precisely when to advance holdings in certain areas at certain times, and when to retreat, as well. Many academicians, however, will tell you that market timing is really not that helpful. To be a highly successful investor and a market timer, you need to be right 70 to 80% of the time. As a market timer, you need to be right twice: when to retreat your stake in an investment and when to get back in. |
Net Asset Value
| The net asset value (NAV) of a mutual fund is the price per share. For money-market funds, the NAV is typically $1. In no-load funds, you'll pay the NAV when you buy the shares. With load funds, the number of funds that you end up with depends upon the sales commission. The NAV of a mutual fund is calculated by taking the value of the securities that the fund is managing and dividing that by the number of shares outstanding. A fund with net assets of $25 million and 1,000,000 shares outstanding has a NAV of $25. |
Rating Mutual Funds
| The Beta Co-efficient: Gauge Your Fund's Volatility The beta co-efficient is an indicator used by many investors and analysts to determine just how volatile a mutual fund is as compared to a standard. The standard of comparison is provided by the Standard and Poor's 500 index. The S&P index is given a beta of 1. Its usual time frame is three years back. In other words, a stock fund that is 20% more volatile than the stocks of that constitute the S&P would have a beta value of 1.2. Those stock funds that are 15% less volatile than the S&P index would have a beta of 0.85. The beta is not a totally indicative depiction of a stock fund's situation. If a fund is "thinly traded," or in other words there are not too many shares outstanding, large price swings are possible whenever shares are sold. In general, however, beta values are a fairly reliable way of determining how a stock fund has done, and in a way, how well it may do in the future. Beta values for many mutual funds can be found in many financial magazines or special investing periodicals such as Investor's Business Daily. Risk vs. Reward and the Alpha How much of a risk-taker you are is directly proportional to how much you stand to gain--and lose. Risk vs. Reward is a concept that nearly all investors struggle with and are constantly aware of. A good example of the relationship between risk and reward are high-yield (junk) bonds. They are amongst the most volatile investments that an investor can make, but on the upside, they also have tremendously high yields. Finding the "happy medium" often times is the difference between a good investor and a great one. Like the beta co-efficient, the standard deviation of a fund is important in determining volatility, and thus the risk involved in investing. The standard deviation takes into account both the upward and downward swing of a fund. In this way, the standard deviation of a fund measures its pure volatility, not in comparison to a standard. But, you may wonder, why should a fund be penalized for fluctuating upwards, or rewarded for fluctuating downwards? That is why neither standard deviation nor beta co-efficient values are totally accepted by all investors. They provide a rough guide, but are by no means flawless. Since the S&P is used to arrive at the beta co-efficient, it is obviously favoring blue-chip stocks (of which the S&P is largely composed). The relationship between a fund's beta value and its actual performance is called alpha. The higher that this value is, the better. Anything over 0 is desirable. If a fund's alpha value equals 0, then the fund did precisely what was expected of it, giving its volatility. The following table will give you an idea of what different alphas have equaled in recent years for the top-performing funds: The Value Line ranking of a stock safety is derived from a complex blend of the stock's standard deviation and other fundamental analyses. This rating is fairly accurate and good for the very serious investor. Value Line rankings are available at all libraries at the reference desk. Turnover Rates The rate at which a mutual fund buys and sells funds is called its turnover rate. A very high turnover rate is a red flag. If a fund has a turnover rate way over 100%, it will translate into increased expenses to the investors in terms of commissions, fees, etc. |
Expense Ratios
| Remember that in addition to mutual funds being groups of funds that investors can buy, they may refer to companies that sell funds to people. In this case, mutual funds are like any other business. They have costs for maintenance and other expenses. An efficient fund is going to have lower expenses. The general rule of thumb is that the larger the fund, the lower its per-share cost is going to be. This is due to the fact that these mutual funds are doing business in great volume. There is definitely the economy of scale which such funds take advantage of. Expense ratios are yet another factor that is very important to look at when buying a mutual fund. You can calculate a funds expense ratio by dividing annual expenses by average net assets. A fund's expenses typically include adviser's fees, legal and accounting fees, 12b-1 fees, but not commissions, interest on loans or income taxes. An expense ratio of over 2% is considered exorbitant. Funds that perform poorly year after year have high expense ratios. That makes sense. Obviously, these funds are not managing their expenses to the highest level of efficiency, and this results in poor performance. But these numbers can be misleading. Consider this: A mutual fund allows investors in with a very low initial minimum investment. As a result, it will have a high expense ratio because it is more expensive to deal with a large group of small investors than a small group of large investors. |
Distributions
| Distributions collectively refer to money that you receive as a result of your investment in a mutual fund. Dividends from common and preferred stocks, interest from bonds, net realized capital gains, return of capital, undistributed capital gains--all of these are distributions. When distributions are issued, you have various options. You can re-invest your distributions, which is the choice that about four-fifths of all investors take. This allows them to obtain more shares automatically. It is possible to re-invest just the income that you receive, and not your capital gains. The other possible option is to have your distributions check mailed to you. Only funds with loads of less than 7.25% can charge commission to re-invest distributions. As a general rule, it is not a good idea to buy shares of a fund right before distributions are issued. You will receive back a part of your investment immediately, but now it is taxable. Most distributions are issued in December and some in July. Each fund varies, so it is a good idea to check with the particular fund that you are interested in. |
Distributions
| Distributions collectively refer to money that you receive as a result of your investment in a mutual fund. Dividends from common and preferred stocks, interest from bonds, net realized capital gains, return of capital, undistributed capital gains--all of these are distributions. When distributions are issued, you have various options. You can re-invest your distributions, which is the choice that about four-fifths of all investors take. This allows them to obtain more shares automatically. It is possible to re-invest just the income that you receive, and not your capital gains. The other possible option is to have your distributions check mailed to you. Only funds with loads of less than 7.25% can charge commission to re-invest distributions. As a general rule, it is not a good idea to buy shares of a fund right before distributions are issued. You will receive back a part of your investment immediately, but now it is taxable. Most distributions are issued in December and some in July. Each fund varies, so it is a good idea to check with the particular fund that you are interested in. |
Loads, Redemption Fees, 12b-1 Plans and Other Impediments
| A load is the fee or sales charge that an investor has to pay to buy certain mutual funds. Not all mutual funds have loads. Those without loads are called, quite logically, "no-load." About 60% of mutual funds carry what are known as "front-end" loads, or those that are assessed when the fund is first purchased. A "back-end" load, or one that is assessed when the fund is sold can be far more damaging if an investor does not pay attention to them. The maximum load allowed by the Securities Exchange Commission (SEC) is 8.5% of the original investment. Most experienced investors don't buy full-load mutual funds. Loads can start adding up quickly, and there is no evidence to suggest that load funds perform better than no-load funds. You, as the investor, are paying for the research and "due diligence" of the broker when you pay a load. Once you become more aware and gain expertise, the need for a broker lessens. Redemption fees are charged whenever you cash all or part of your shares. Unlike loads, redemption fees are usually small and they do disappear after a while. Nevertheless, a wise investor should be aware of whether or not his/her fund charges these fees and how much they are. In 1980, the SEC authorized the 12b-1 (distribution) plan. This allows mutual funds to charge 12b-1 fees, which are used in the marketing and distribution expenses that are entailed. This includes costs of marketing, publishing annual reports and prospectuses, and to pay brokers themselves. Any 12b-1 fee in excess of 1% is too high. In essence, funds that charge a 12b-1 fee are not truly a "no-load" fund. These types of fees may seem minuscule, but when investing large amounts of funds, they can begin to add up quickly. The most serious impediments that an investor may encounter when buying a mutual fund is a high sales charge (8.5%), extremely high volatility, and "back-end" loads, or deferred-sales charges. These types of fees can accumulate rapidly. There are numerous other handicaps which will undoubtedly effect fund performance, but none would be as serious as the aforementioned ones. These are things that any investor must look for before purchasing mutual funds. |
Weather Funds
| All-weather Funds Quite simply, all-weather funds are those that do well in both bear and bull markets. They are the best for those investors seeking stability and reasonably high returns. Mutual Shares is one of the most famous all-weather funds. You may be wondering how certain funds can do well in both types of markets. Many all-weather funds invest in undervalued securities, or companies who are currently going through tough times. Generally, these funds have low price to earning (P/E) ratios. These companies' prices usually don't sink because they are already fairly low. Another way that all-weather funds maintain balance is investing in stocks with high dividends. These companies' prices also do not fall that much when the market goes sour. Yet another way that all-weather funds are successful is that they diversify beyond just stocks. These types of funds are called balanced funds. As a result, all-weather funds have the lowest beta values of all mutual funds. This is how diversity provides stability. Fair-weather Funds It may seem strange why anyone would want to invest in anything other than all-weather funds. One of the reasons is that all-weather funds do not yield the highest returns. If you have the courage to hold onto fair-weather funds, you could make more money. This is again a classic case of risk vs. reward. Many fair-weather funds tend to stay fully invested in stocks and invest in small-company stocks, which are more volatile than blue-chip stocks. Fair-weather funds have higher beta values than all-weather funds, as well. Foul-weather Funds Foul-weather funds are similar to all-weather funds in that they both tend not to sink very low during bear markets. There are basically two types of foul-weather funds: very conservative funds and very risky funds. The conservative funds, as you would expect, do not rise far during bull markets. A prime example of a foul-weather mutual fund is Dreyfus Strategic Aggressive. Unseasonable Funds Unseasonable funds can basically be summed up in one word: losers. These funds perform horribly year after year. The reason? The causes are quite complex and intertwined, but one of the most important of these reasons is poor management. Unseasonable funds, however, do serve one very useful purpose for investors: their track records show that past performance is a very real and reliable indication of how a fund will do. |
Weather Funds
| All-weather Funds Quite simply, all-weather funds are those that do well in both bear and bull markets. They are the best for those investors seeking stability and reasonably high returns. Mutual Shares is one of the most famous all-weather funds. You may be wondering how certain funds can do well in both types of markets. Many all-weather funds invest in undervalued securities, or companies who are currently going through tough times. Generally, these funds have low price to earning (P/E) ratios. These companies' prices usually don't sink because they are already fairly low. Another way that all-weather funds maintain balance is investing in stocks with high dividends. These companies' prices also do not fall that much when the market goes sour. Yet another way that all-weather funds are successful is that they diversify beyond just stocks. These types of funds are called balanced funds. As a result, all-weather funds have the lowest beta values of all mutual funds. This is how diversity provides stability. Fair-weather Funds It may seem strange why anyone would want to invest in anything other than all-weather funds. One of the reasons is that all-weather funds do not yield the highest returns. If you have the courage to hold onto fair-weather funds, you could make more money. This is again a classic case of risk vs. reward. Many fair-weather funds tend to stay fully invested in stocks and invest in small-company stocks, which are more volatile than blue-chip stocks. Fair-weather funds have higher beta values than all-weather funds, as well. Foul-weather Funds Foul-weather funds are similar to all-weather funds in that they both tend not to sink very low during bear markets. There are basically two types of foul-weather funds: very conservative funds and very risky funds. The conservative funds, as you would expect, do not rise far during bull markets. A prime example of a foul-weather mutual fund is Dreyfus Strategic Aggressive. Unseasonable Funds Unseasonable funds can basically be summed up in one word: losers. These funds perform horribly year after year. The reason? The causes are quite complex and intertwined, but one of the most important of these reasons is poor management. Unseasonable funds, however, do serve one very useful purpose for investors: their track records show that past performance is a very real and reliable indication of how a fund will do. |
Total Return
| How can you tell if a mutual fund is a good mutual fund? One of the best indicators is to check its total return. Obviously, if mutual fund is giving you a good total return, it is one that has proved itself to be valuable to you. Total return includes everything--dividends, capital gains, interest, etc. It is expressed as a percentage of the original net asset value. Assuming that you have re-invested your distributions (see Distributions), then figuring out yield is not that complicated. (Year-end # of shares * Year-end Net asset value) - (# of shares you owned at the beginning of the year * Beginning Net asset value) * 100 divided by (beginning # of shares * Beginning Net asset value) |
Classification of Mutual Funds
| There are a myriad of different mutual funds. The Investment Company Institute (ICI) is an association for mutual funds that classifies the many types of funds. Essentially, there are three basic types of mutual funds: equity funds, fixed-income funds and money-market funds. If you are not completely sure what classification a mutual fund belongs to, check its beta co-efficient. The funds with the higher betas will probably be aggressive growth funds (equity or stock funds), and those with lower betas will be fixed-income funds. Aggressive Growth Funds Aggressive growth funds are stock funds that have primarily one objective--maximum capital gains. Capital gains are just the increase in the value of an investment. These types of mutual funds invest in many different securities, including new industry stocks, small-company stocks, and practice investment techniques such as selling stocks short, futures, and options. Aggressive growth funds tend to be the most volatile of funds, as well. Examples of aggressive growth funds are Fidelity Magellan, Tudor, 20th Century, etc. Growth Funds Growth funds are those that invest in the stocks of well-established, blue chip companies. Dividends, and consequently steady income, are not the primary goal of these types of funds. Instead, they focus on increasing capital gains. Examples of growth fund are Fidelity Destiny I, Ivy, Janus, T. Rowe Price New Era, 20th Century Growth, Manhattan and many more. Growth and Income Funds Growth and income funds incorporate both increased capital gains and producing steady income. They are less volatile than aggressive growth funds. Examples of these funds are Evergreen Total, Investment Company of America, 20th Century Select, Vanguard Index Trust, Windsor II, etc. Equity (Stock or Income) Funds Equity funds allow investors to own a piece of the company that they have invested in, like common stocks. Stocks have historically been the best investment bar none. They have outperformed all other investment vehicles in the long term, but there is added risk. See the section on stocks and bonds for more information about this. Equity funds seek to produce a high level of current income by investing primarily in equity securities of companies with solid reputations and a record of good-paying dividends. Decatur and Fidelity Puritan are examples of equity funds. Balanced Funds Balanced funds have a portfolio mix of bonds, preferred stocks and common stocks. Balanced funds generally aim to conserve investors' initial investment, to pay an income and to aid in the long-term growth of both the principle and the income. Examples include Phoenix balanced, Wellington, Loomis-Sayles Mutual, etc. Bond Funds These type of mutual funds invest in a mixture of corporate and government bonds at all times. The most sophisticated investors often switch between short-term, intermediate-term and long-term bonds, depending upon the direction of interest rates. Short-term bonds are those with maturity of less than three years; intermediate bonds are those that have bonds of three to ten years, and long- term bonds are over ten years. For a more comprehensive description of bonds, refer to that section. Global Funds Global funds are those that invest in equity securities of companies around the world and in the United States. These funds can change the percentage of their allocation in foreign and domestic markets, as well. For example, if there are major problems in foreign markets, global funds will allow the mutual fund company to pull out money invested there. International funds International funds invest in equity securities of companies located outside of the United States. Two-thirds of their portfolios must be invested in these companies at any one time. Many of these international funds invest in the emerging markets of nations around the world. They do not offer the flexibility of the global funds because of the two-thirds minimum requirement. Fixed-Income Funds Fixed-income funds are safer than equity funds, but as always, do not yield as high returns as the latter do. These types of funds are geared towards the investor who is approaching old age and doesn't have many earning years left. Many investors hope to draw a steady income from these types of mutual funds. Bond funds fall into the category of fixed-income funds. Fixed-income funds entail lending out money to buy Certificate of Deposits (CDs) or bonds, and as a result, your principle isn't expected to take a great hit in the event of the market heading south, but at the same time, your principle won't appreciate greatly when the loan comes due either. Money-Market Funds Money market funds are generally the safest and most secure of mutual fund investments. They invest in the largest, most stable securities, including Treasury bills. Money-market funds have beta co-efficient values of zero because the chances of your principle being eroded are very minimal. How do these funds work? Money-market funds are like fancy checking accounts and the best part is that they are risk-free. If you invest a thousand dollars, you will get that money back. It is simply a matter of when you get it back. A thousand dollars will get you a thousand shares. Usually the prices of shares in money-market funds are kept at around $1. As an investor, you will be given checks which you can use against your deposit. The minimum amount for these checks, however, is usually around $250 or $500. When investing in a money-market fund, you should pay attention to the interest rate that is being offered, along with the rules regarding check-writing. Money-markets have allowed investors to reap high yields on their deposits, and have made the entire investment process more accessible to people. The interest rates on money-market funds are changing nearly day to day. In times of inflation, these funds have had high yields--like 18% in the early 1980s. The interest rate is very important information. Many investors believe that even 1% is not worth the trouble of shopping around. The graph below shows the difference 1% makes on $5000 invested for different duration. The Importance of 1% Yield 1 Year 3 Years 5 Years 10 Years 15 Years 5.25% $5,268 $5,847 $6.490 $8,423 $10,933 6.25% $5,320 $6,022 $6,818 $9,296 $12,676 7.25% $5,372 6,203 7,161 10,257 14,690 Real Estate Funds Real estate has often rivaled common stocks as amongst the most profitable of investments. A drawback to investing in real estate is that it is not very liquid. In other words, an investor cannot pick and sell and turn around and buy as quickly as with other investments. Mutual funds provide some of this liquidity. Real Estate Investment Trusts (REITs) are sold like stocks on an exchange. They are not exactly mutual funds. REITs provide the most liquidity, along with the lucrative benefits of investing in real estate. T. Rowe Price, Vanguard and others have many REITs that you can invest in. Index Funds Indices (pl. index), as you know now, provide a snapshot of how the market is doing on the whole. The most famous indices are the Dow Jones Industrial Average (about 30 blue-chip stocks) and Standard & Poor's 500 Index. Both of these give a view of how the market is doing in general, but for more a specific view, the Wilshire 5000 and the Value Line Composite provide more accurate information. Index funds try to emulate a market index, most often the S&P 500. Because of expenses, these index funds perform a bit worse than the index itself. An example of a good index fund: Vanguard's 500. Fund Families A family of funds are a group of funds under one organization. When you invest in a fund of families, you can switch between different types of funds with ease. Some of the best fund families available are Strong, T. Rowe Price, Dreyfus, Fidelity, Vanguard, etc. The largest family is Fidelity, with over 100 different available funds. See the table of some popular funds at the end of this section. |
Open-end Funds vs. Closed-end Funds
| Open-end funds are those funds in which the company can always issue more shares outstanding. This, in effect, adds to the net assets of the company. A closed-end fund (or publicly traded mutual fund) is one that is bought and sold just like the shares of a regular stock. The number of shares in a closed-end mutual fund stays fixed. This is the way in which it differs drastically from an open-end fund. Closed-end funds also have a commission which gets paid to brokers because the shares of these funds are traded over-the-counter, or in the same way that stocks are. One note of caution about closed-end stock funds: If you buy a stock fund when it is first offered for sale, you will undoubtedly take a hit. Because the fund's shares are offered at their actual value, they start trading at a discount almost immediately. So the best thing to do is to stay away from closed-end stock funds. Closed-end funds don't really retreat that much during a downturn in the market, but they are preferable for the long-term investor. If you're the type of investor who buys and sells shares rapidly, then you would lose a lot of money in the commissions of closed-end funds. Closed-end Funds vs. Open-end Funds Type How Shares are Bought Sales Price Shares Outstanding Closed-end Stock Exchange Market price Fixed Open-end Directly through fund Net asset value Varies |
What is a Mutual Fund?
| You've undoubtedly heard about these investment vehicles called mutual funds, but what exactly are they? Simply stated, mutual funds are like an insurance policy. They are a conglomeration or collection of many different types of securities. When investors come together and want to buy securities as a group, you have a mutual fund. Each investor has a proportional stake in the securities based upon how much money he/she contributed. Mutual funds are a cheap and an easy way for the average person to own several hundred stocks. They've been around for quite a while, too. The first mutual fund was established in Boston well over seventy years ago. Today, there are over 2000 mutual funds. Mutual funds can also be the investment companies that buy and sell securities. |
Mutual Funds Introduction
| The potential of mutual funds is enormous. Mutual funds can bring the average investor great returns if he/she is willing to follow two basic tenets-- doing research and having patience. These two characteristics, as you will learn, define any successful investor. Many people, adults included, do not have the vaguest idea of what mutual funds are. In a way, they can be described as a group of people investing for a common interest. They are appealing to the average, conservative investor. And they're easy enough so that the common investor can do it on his/her own. The world of mutual funds is so vast that it can be overwhelming. There are many types of funds, so take it slowly and absorb the information. We'll try to give you a flavor of what mutual funds are. The purpose of this section is not to tell you precisely when and in what to invest but to help you become aware. The informed decision, after all, is far more sound than one made on impulse. Beginning to decipher this complex mass of information and concepts will help you make better choices. People invest in mutual funds for so many different reasons, as you can see below. Over time, mutual funds have proved themselves to be solid investments--but don't take our word for it. See and learn for yourself! |
Margin Accounts
| There are two ways to purchase stocks: the buyer can pay the purchase price in full or on by using a margin account. In a margin account purchase, the buyer pays a portion of the purchase price and the broker lends the difference. The buyer in turn pays interest on the broker’s loan in addition to the usual commission fees. For collateral, the broker holds onto the stocks. Dividends earned from the stocks are used to help offset the interest payments. Margin is determined by the following equation: M=V-L ___x100 V It looks complicated, but it isn't. Here's an explanation: M is the margin, V is the market value of the securities, and L is the broker’s loan. The ratio is expressed as a percentage. The lowest initial margin, or the margin at the time of the purchase, is 50% (as set by the Federal Reserve Board). After the purchase of the stock on margin, there is a maintenance margin below which the margin is not allowed to fall. On the New York Stock Exchange, the maintenance margin is 25%, but brokers can set their own margins (30% is common). If the margin falls below the maintenance margin, the broker calls for additional cash from the investor. If the money does not come within the specified time, the broker immediately sells the stock. Buying on margin is a technique that many investors use. It allows better utilization of available resources. But as the investor, you must be completely aware and positive about buying before you actually do so. |
The Ex-Dividend
| Abbreviated x or xd, ex-dividend really means without dividend. When a stock is in an ex-dividend period, it means that a buyer is not entitled to receive the next dividend payment given by the company. A dividend-issuing company tallies its shareowners on the so-called record date; therefore, the transfer of ownership that occurs when a stock is purchased must be done by the record date for the new owner to receive the next dividend. The NYSE and the NASDAQ, among others, require that the buyer in every transaction be recorded with the issuing corporation by the third business day following a trade. Therefore, the ex-dividend period on exchanges that honor the "T plus 3" rule is two days. During those two days, the transfer of ownership of the stock will not be completed until the business day after the date of record. |
Short Selling
| You may be wondering, "How is it possible to make money when the market generally is doing badly?" The answer: short selling. As an investor, you might at some point decide that a certain stock is overvalued and is due for a fall in stock price. In such a case, an investor can sell short a stock. The investor arranges to have the broker borrow the stock from another investor; then the stock is sold. The broker holds the cash from the sale as collateral. If the stock goes down, then you, as the investor that is selling short, can buy back the stocks at the lower price and keep the difference as profit. Therefore, you receive the cash collateral, less the cost of the repurchased stock. Generally, there is no charge for borrowing stock, although sometimes a premium is charged. When borrowing, the investor must deposit $2000 or the required initial margin, whichever is the greater. This deposit is returned when the investor buys back the stock and it is returned to the rightful owner. Because the stock is not actually owned by the stock lender while you are short selling it, you must pay the lender any dividends which are declared during the period the stock is shorted. The SEC only allows short sales to be executed on an uptick. This means that the stock is increasing on the exchange. If the stock is decreasing, then the investor is not allowed to sell it short. When selling a stock short, you must be very careful to understand that there is no limit to the losses involved. When buying stock, the limit of the your loss is the price of the share; that is, the maximum per share loss is the price of the share. However, in the case of shorting, the stock can theoretically go up indefinitely and has no limit. Also, if a large number of short sellers are trying to close out their position by purchasing a stock, the prices might be driven to very high levels, thus increasing your losses. |
Stock Options
| Companies are increasingly offering employees stock options as a partial substitute for payroll in an attempt to build morale and company pride. Due to this trend, there are many people who have a substantial monetary interest in understanding them. There are two types of stock options: call and put. A call is the right to buy a specified number of shares at a given price before a specific date. A put is the right to sell a specific number of shares at a given price before a specific date. An important difference between futures (not discussed here) and options is that options are a right and not an obligation to buy the shares. The price at which the option may be bought or sold is called the exercise or striking price. Options do expire at a time called the expiration price. An option is known as "in the money" has an exercise price below the current stock price if it is a call option, or above the current price if it is a put option. Expiration months are set at intervals of three months for the cycles. An option expires at 11:59 P.M. Eastern Standard time on the Saturday immediately following the third Friday of the expiration month. The exercise price is set at intervals of five dollars for stocks under $50, ten for stocks $50 to $200, and twenty dollar intervals for stocks trading over $200 per share. Initial exercise prices are set above and below the stock price at the time the option is opened. For example, if a stock is trading for 48 3/8 per share, the exercise prices would be set at 30 and 40 (for puts and calls). If the stock is very close to the normal initial exercise price (e.g. 40 1/8), the option is set at the standard price as well as above and below the standard price. There are several things you must realize before trading options. (1) Options do not exist on every single stock--in fact, only a small percentage of stocks have options that trade on them. (2) When you want to trade an option, look in the financial newspapers to see what stocks have options trading on them, and look to see what months and strike prices are available. (3) Each option contract covers 100 shares. When the newspapers show that an option is prices at 1 and 1/2, that means that those contracts are $150 each. In summation: If you think a stock is going to go up, there are essentially three ways to make money. You can buy the stock, buy a call, or write a put. If you think a stock is going to go down, there are also three ways to make money--you can do the opposite of what you do if you think the stock is going up. You can short the stock, write a call, or buy a put. Options can be very risky, but as always, very profitable if you know what you are doing! |
U.S. Treasury Bonds, Notes, and Bills
| U.S. Treasury bonds, notes, and bills are interest paying securities representing a debt on the part of the U.S. Government. Bonds and notes are usually issued in denominations of $1,000 and up, paying interest semi-annually until the end of their maturity which is 5 years in the case the bonds and 5 to 7 years in notes. The amount of semi-annual interest paid is determined by the coupon rate specified on the bond and is calculated on a 365-day year basis. Semi-annual interest equals one- half times the face value of the bond multiplied by the coupon rate. Bonds may be priced higher or lower based on current interest rates; from this fluctuation arises bond trading. The current yield is the rate the investor receives based on the price actually paid for a bond, and is computed by multiplying the face value of the bond by the coupon rate and dividing by the purchase price. For example, a $1,000 face value bond with coupon rate of 10% and purchased at $800 has a current yield as follows: current yield = = 9.41% The yield to maturity (YTM) takes into account the years remaining to maturity, annual interest payments, and the capital gain (or loss) realized at maturity. It is much more useful in determining the value of a bond. It is obtained from special tables, though it can be approximated: I = annual interest rate A = B =, where M = the current market price of the bond and N = years to maturity U.S. Treasury Bills (T-Bills) are U.S. government debt obligations issued by the Federal Reserve. Offered in denominations of $10,000 and up, they are issued in differing maturities, but all within one year. There are 3 month, 6 month, 9 month, and 1 year bills. The bonds are purchased at the face value less the interest that the bond offers. For example, a $10,000 face value 182 day T-bill with a 10% discount interest rate would cost the buyer at the time of purchase $9494.44 ($10,000 - $505.56). Tax-Exempt Bonds Tax exempt bonds are issued by state and local governments and are free from federal income tax on interest payments, but capital gains are taxable. They are often issued in $5,000 denominations and pay interest semi-annually. Holders of out-of-state bonds, however, may have to pay income taxes on the interest as specified by the holder’s home state. For example, a Los Angeles resident holding Chicago municipal bonds would be subject to Los Angeles income taxes on interest from the bond. |
Registration of Securities
| Registration Statements Offering registrations are used to register securities for an initial public offering. Part 1 of such a registration is the publication of a preliminary prospectus (commonly referred to as a red herring, a reference to the red writing on the left side of the cover warning that the prospectus is only preliminary). Part 2 of the registration contains information not required in the prospectus, including expenses of issuance and distribution and indemnification of directors and officers. Trading registrations are filed to permit trading among investors on a securities exchange or in the over-the-counter market. These registrations do not include a prospectus. Prospectus After reviewing the offering registration, the SEC chooses whether or not to approve the sale of the security. If the SEC approves the sale, any changes required by the SEC are incorporated into the prospectus. This document must be made available to investors before offering the stock for sale, and it includes the offering price of the stock, which might have changed since the publication of the red herring. Form 8 This form is used to amend or supplement any 1934 Act report already submitted. Listing Application Like the annual report to shareholders, a listing application is not required by the SEC but rather is submitted to the stock exchange (e.g. NYSE or AMEX) to document proposed new listings. It is usually filed at the same time the Form 8 is filed with the SEC. |
SEC Corporate Filings
| Federal securities laws were designed to provide disclosure of financial information about companies seeking an initial public offering (IPO) or those already publicly held. The Securities Act of 1933 requires that a company, before offering securities to the public, must file a report detailing several categories of information specified by the Securities and Exchange Commission (SEC). The Securities Exchange Act of 1934 deals mainly with securities already publicly held. It requires the registration of securities listed on a national securities exchange, as well as over-the- counter securities in which there is a substantial public interest. Issuers of such securities must publish periodic reports outlining current material information. Periodic Annual Reports There are several reports that companies must file, as well as issuers of securities. Most people may find these reports boring, but they do provide much information that the informed investor should know. Here is a few of these reports: 10-K This report provides a comprehensive overview of the issuer of the security. It must be filed within 90 days after the close of the company’s fiscal year. Annual Report to Shareholders The annual report is the principal vehicle that most major companies use to communicate with shareholders. However, it is not a requirement mandated by the SEC, and this lack of rules surrounding this document gives companies considerable discretion in regard to the information contained in an annual report. An investor should realize this when reading an annual report. In addition to financial information, an annual report can provide details of the business that might not be reflected in other SEC filings, such as marketing plans and forecasts, that shareholders might study. 20-F This is an annual report/registration statement filed by certain foreign issuers of stocks in the United States. It contains miscellaneous business details of the foreign company. Form 20-F must be filed within six months of the end of the fiscal year. 10-Q This quarterly report filed by most companies provides an unaudited look at the company’s quarterly financial position. It is a useful reference for an investor to inspect a company during the middle of its fiscal year. Form 10-Q must be filed within 45 days after the close of the fiscal year quarter. Corporate Changes and Voting Matters Most of the successful investors know the companies in which they have a stake inside and out. This means keeping up with any changes going on within the company that might have an effect on the price of its stock. The following are additional reports that stockholders should know: 8-K Form 8-K is an unscheduled report of material events or corporate changes deemed of importance to the shareholders or SEC. Although the form does not have a set filing corresponding to the fiscal year, some of the items of the report are due within five days of the event while others are not due until 15 days after the event. 10-C Used only by over-the-counter companies, this report is used to file changes in name and amount of NASDAQ-listed securities. Similar in structure to Form 8-K, the 10-C must be filed within 10 days of the change. |
Stocks and Bonds Guide
An Introduction to Stocks and Bonds Americans have had a love affair with stocks and bonds for the longest time. The stock market is one aspect of investing that nearly everyone has heard of. Recently, the market has done exceptionally well--as a result, people's interest has been piqued. The stock market has definitely had its ups and downs. Like the gold rush, the stock market has periodically made people feverish. In the process, it has made millionaires and ruined many people. Historically, stocks and bonds have been the #1 and #2 investments respectively. Nothing has outperformed them in the long run. A Brief History |