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Mutual Funds

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Mutual Fund Summary

A mutual fund is an investment company which invests money entrusted to them in exchange for shares of the fund. They pool large sums of cash from many investors and buy assortments of investment instruments. The funds provide their shareholders with capital gains, dividends, and income distributions from the instruments purchased in the fund. Mutual funds are not assets or investment instruments. They are investment vehicles which are composed of hundreds of different individual assets. Fortunately, your investment vehicle comes with a fully staffed management team which researches, analyzes, and investigates funds for you.

Mutual Funds

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Fund Structure

All mutual funds, by requirement, have specific essential characteristics defined for them. These characteristics are the basic value of each fund, the fund’s expense structure, and the fund’s classification. The basic value is defined by the Net Asset Value, and can be related on a total or per share basis. Funds have many potential classifications, defined both by the divide of bonds to equities and the type of equities or bonds within the fund. Some of these are oriented towards valuation based investment, while others are oriented towards growth based investment. The fund’s documentation explains all of the characteristics about a mutual fund except Net Asset Value, which changes with each trading day.

Mutual Fund Basics

Mutual Fund Basics

Mutual funds are investment companies which combine money you entrust to them with a large pool of funds from other investors. They use the money to trade bonds, equities, and their many subtypes. In exchange, they give you partial share ownership of the fund’s total holdings. Shares are purchased from the fund, share exchanges, or previous fund investors. Once you own a fund’s shares you have a fractional ownership of the fund and by extension, all investments they own. If the investments climb in value, the value of your share ownership increases. If these investments decline in value, you will suffer a loss. The fund provides you with capital gains and dividends from the returns in accordance to your percentage of ownership.

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Net Asset Value

Net Asset Value

Net Asset Value, abbreviated as NAV, is the primary pricing method of mutual fund portfolios. A fund’s net asset value measures the total value of all assets, minus all liabilities of the fund. The NAV is essentially a snapshot of the fund’s net worth which is accurate for that single day. Since net asset value is based on the market value of investments owned, NAV is only updated when the market closes at the end of each day. The daily NAV is only good for the time between the close of today’s market and the opening of the market tomorrow. When the market opens, prices change and the net asset value is outdated.

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Portfolio Classifications

Portfolio Classifications

Mutual Fund portfolios vary in their risks and rewards based on the investments that compose the fund. In order to understand these classifications, you must comprehend the three traits they are categorized from. These are value investments, growth investments, and capitalization size. Value funds use value investments while growth funds use growth investments.

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Fund Trading

Fund Trading

The pricing of many mutual funds is their Net Asset Value, shortened to NAV. Net Asset value is the net worth of the fund, calculated as the total market value of assets minus its liabilities. NAV is updated at the end of each trading day when the investments owned by the fund reach their final day price. Mutual funds trading at their NAV pricing use “Late Trading”, which means that the funds themselves only execute buy and sell orders when prices are static. Unlike stock and bonds, which allow you to liquidate your holdings in as little as 10 minutes if you have a trading partner, mutual funds will only allow you to trade daily after markets have closed.

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Mutual Fund Documentation

Mutual Fund Documentation

Mutual funds have 3 specific documents that you can use to determine if the fund is going to meet your investment needs. Funds are required to release a fund prospectus, annual financial report, and statement of additional information. These documents explain essentially everything you need to know about the fund.

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Mutual Funds Expenses

Mutual funds have multiple fees and commission structures. All expenses are passively charged to your account with the mutual fund. You will never receive an external bill directly mailed requesting you to pay an amount in addition to your deposit with the fund itself. All fees are charged against the money you are currently investing or have invested.

Front End Load

Front End Load

The front end load is a sales commission charged against your investment into a fund. Your investment will be reduced by this expense, since a Front End Load ranges anywhere from 0% up to 8.5%. This fee is distributed to the brokerage, advisor, or financial planner who referred you to the fund, other marketing fees, the company who manages the fund, and potentially other parties. The rest of the cash is invested directly into the fund. A fund carrying a front end load is typically referred to as an “A-share class” for simplicity.

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Back End Load

Back End Load

A back-end load is a deferred sales charge applied on withdrawals from a fund. Mutual funds with a back end load are commonly known as “B-share class” funds. This commission is applied to your withdrawal and reduces the amount actually received. If you are withdrawing $10,000 you have invested in a fund and have a 5% back-end load, you will only receive $9,500. These loads commonly decrease over time, reducing the loss for investors who hold shares of the fund long term. Instead of a 5% back-end load fee, if you held the fund for an additional time period you may be charged only a 3% load fee. Sometimes back-end loads are reduced to zero if you hold the fund long enough. These reductions compensate you being a long term stakeholder and not rapidly exiting. You should note that funds which reduce back-end loads typically charge higher annual operating expenses.

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Level Load

Level Load

Funds with level loads have both front and back end loads. Shares of this class are typically referred to as “C-share” for simplicity. You will be charged a front end load deducted from your initial investment. You will be charged a back end load on your withdrawal, and in between these loads you will be charged regular annual operating fees. That is just as expensive as it sounds. The front end load is lower than most front end load funds, and marketers will say this makes it inexpensive. However, these funds typically don’t reduce the back end load if you hold them for a long period of time. It compensates your fund’s management team for the reduced front end load. To finish, funds will often charge additional annual fees in exchange for the “favor” of splitting the load.

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No-Load Funds

No-Load Funds

A “No Load” fee is not an expense, but a lack of load expenses. These funds charge neither a front end nor a back end load. All of the cash you invest in the fund remains in the fund both at initial investment, and you receive all of the cash at financial withdrawal. These are generally extremely rare funds and are not often advertised by investment brokers. Brokers, advisors, and financial planners are compensated directly by loads, so they will direct you to every fund with a load before showing you the No-Load fund selection. They typically must be directly requested if you want information on no load funds. You should note that operating expenses and 12b-1 fees are still charged against No-Load funds. 12b-1 fees still compensate the brokers, advisors, and planners who market them. These groups may refer you to high end 12b-1 fees before showing you cheaper no-load funds.

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Operating Expense

Operating Expense

Operating expenses finance the fund’s costs and compensate management teams for their provided services. They are expressed as an annual percentage of all assets under management. Operating expenses are deducted from your investment once a year, every year that you’re invested in the mutual fund. You should never receive a direct bill requesting payment. These expenses come in 3 divisions: Advisory Fees, Operational Fees, and Communications Fees.

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12B-1 Fee

12B-1 Fee

A 12b-1 fee pays the marketing expenses of a mutual fund. This fee operates like a secondary operating expense, deducted from the assets under management once a year. 12b-1 fees are essentially an ongoing commission that compensates financial planners, advisors, and brokers for referring customers. It also pays for future marketing from these sources.

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Total Mutual Fund Expense

Total Mutual Fund Expense

The total mutual fund expense ratio is the total of all annually charged expenses deducted from the portfolio once per year. This normally consists of the combination of Operating Expenses combined with 12b-1 expenses. You should judge funds based on their total expense ratios just as much as their estimated performance. You always know in advance what a fund will charge you. Meanwhile, variables such as estimated future performance can rapidly become irrelevant due to market crashes and errors. These costs directly affect your performance anyway. They are taken directly from money within the fund, reducing the compounding of interest and earnings. The higher these total fees are, the greater the drag on performance. These fees hurt your ability to compound interest long term by reducing your actual earnings. It’s equal in importance to future performance.

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Redemption Fee

Redemption Fee

A redemption fee is similar to a very temporary high end load. These fees reduce your withdrawal amount if you sell the shares entitling you to partial ownership of the fund within an extremely short time frame. If you sell out quickly, these fees are applied in addition to any back-end load and commissions you may face. You should always check in advance to see if redemption fees will be applied on sale, how long they last, and the amount they reduce withdrawals.

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Fund Classifications

Mutual funds can be divided into many major classifications and then split further into subsections for investment. Fund classifications inform you of what a fund’s investments are and how the fund earns a profit for shareholders. Several classifications are based on investment only in equities. Some are bonds only. They divide based on which type of equity or bond the fund purchases and trades. You should memorize these classifications and each one’s positives and negatives. Then you’ll know which will type will empower or hinder your portfolio based on your needs.

Open End Funds

Open End Funds

Open end funds are entered and exited directly through the mutual fund itself. The mutual fund continuously sells shares to purchasing investors. If investors want to exit, they sell the shares they bought directly to the fund. These fund categories are extremely common, covering the vast majority of mutual funds available on the market.

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Closed End Funds

Closed End Funds

Closed end funds are not purchased or sold from the fund itself. These funds trade on share exchanges, so the fund managers do not have to issue or redeem shares on a regular basis. They issue shares at the beginning of the fund via an initial public offering. Once the initial desired amount of shares has been sold to the first investors, the fund managers use the finances raised to purchase the fund’s investment instruments. After this point the shares are traded openly between investors.

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Active Funds

Active Fund

The vast majority of mutual funds are actively managed, hence the name Active Funds. Active funds have a full scale management team that set the fund’s objectives. They track, research, purchase, and sell investments fitting within the fund’s prospectus. Instead of having to make independent decisions you simply allow active fund managers to operate on your behalf.

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Index Funds

Index Fund

ndex funds passively invests only in shares that are within a specific index tracked by the fund. They’re also known as passive funds. Index Funds do not trade based on a manager’s predictions of the market. Instead, a passive fund attempts to hold the exact same ratios of each investment on an index or exchange. If an exchange adds a company to the index, or a firm’s share fits requirements for inclusion in the fund, index funds will add their stock to their holdings. It will be added to the exact proportion it has on the exchange.

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Unit Investment Trust

Unit Investment Trust

A Unit Investment Trust is fixed portfolios of assets sold to investors. You purchase a share or set of shares, called units, from an investment bank at a small premium to the net asset value. That investment bank purchases securities, equities or bonds, from the market and deposits them in the unit investment trust. The UIT will occasionally send you profits earned. The payment schedule is defined by the trust, occurring monthly, quarterly, bi-annually, or annually. The founders of the Unit Investment Trust earn money from selling shares slightly above the actual net asset value of the UIT. They always sell entry at a premium to net asset value.

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Money Market Funds

Money Market Funds

Money market funds are “cash instrument” based mutual funds. They buy into extremely short-term commercial paper markets, which are used to fund overnight loans that mature extremely quickly. They also buy into certificates of deposit, ultra-short term debt instruments, and repurchase agreements. The securities in the fund last from a few days to a few months.

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Equity Funds

Equity Funds

A large percentage of individual investors already own or will buy equity-based mutual funds. These funds invest almost completely in equities, but also invest, by requirement, in other instruments. Their redemption fund will be made up of cash and cash equivalent instruments, sometimes ultra-short term debts. But apart from their redemption fund, they own almost purely equities. If the fund is allowed to invest outside of its main classification, their prospectus will notify you of that privilege. You will also see it represented in the list of investments released in the fund’s annual informational documentation. Equity funds come in a wide variety of specializations and classifications. Some of these funds are divided based on locations they invest in, while others are divided based on their specifications.

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Mutual Fund Family

Mutual Fund Family

A mutual fund family is created when giant companies make groups of mutual funds. The large investment companies are the mutual fund family parents, and their various creations are the mutual fund family “children”. They create massive groups of funds called fund complexes, fill them, and leverage their massive resources to market the complex instead of individual funds.

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Time Based Bond Funds

Time Based Bond Funds

Many bond funds are categorized by their length, in addition to their target sector or bond type. Some of these are corporate bond funds, investing only in bonds released by corporations. Some invest in government bonds within a time frame, and others invest in agency, municipal or other bond types. For example, you will see titles such as “High-Yield Mid-Term Corporate”. This shows the targeted subtype, term, and bond categorization. If they don’t display a time frame, but list the average duration or average time to maturity, this list will help you decipher the category.

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High Yield Bond Funds

High Yield Bond Funds

High yield bond funds invest in bonds which offer high return in exchange for high risk. These vehicles are determined by their credit rating, with high yield instruments being rated below BBB or BAA. Credit ratings is based on a firm’s liquidity, profitability, cash flow, and existing debts. Their credit rating indicates these firms are moderately to highly likely to default.

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Tax Free Bond Funds

Tax Free Bond Funds

Tax free bond funds purchase bonds with tax exemptions under specific circumstances. When purchasing these bonds, they ensure that these conditions are met, providing tax free income for the fund shareholders. These usually consist of American municipal bonds within the same state. A person buying a Florida municipal bond fund may receive tax exemption if they live in Miami, Florida and possibly federal level United States taxation. Depending on the state laws of Florida, they may receive tax freedom at the municipal, regional, and national level.

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Government Bond Funds

Government Bond Funds

Government bond funds use investor’s funds to purchase bonds issued by a specific sovereign government or group of governments. Government bonds can repay their issues using taxation, the printing of their own currency, or repayment using a stable foreign currency. The nation selected will be specified by the bond fund’s prospectus or investment objectives. Based on the selection, and your relation, a bond fund will be investing in your domestic nation or foreign nations. In either case, you should ensure that the person managing the government bond fund is both experienced and specializes in the target nation.

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Hybrid Fund & Balanced Funds

Hybrid & Balanced Funds

Mutual funds can contain a mixture of both bonds and equities. Funds which contain both are known as hybrid, balanced, or mixed funds. Their specific name depends on their asset allocation ratio. If the fund contains an equal split of bonds and equities, they are balanced funds. An unequal mix is known as a mixed fund. These contain divided percentages of equities and bonds. A fund containing forty percent bonds, and sixty percent equities would be a mixed fund.

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Mutual Fund Performance

Performance is a key reason you open and acquire mutual fund accounts. By handing your portfolios over to a professional management team, you hope the team will be able to acquire substantially higher amounts of return. This is not always the case. It’s often not the case, since over 60% of funds in many categories fail to beat the market. You must analyze the fund’s performance in the past and estimate the fund’s future performance. You should make sure that you are comparing and reviewing mutual fund performance in the correct contexts.

Relevant Comparisons

Relevant Comparisons

When you are comparing mutual fund performance, you should remember that all mutual funds are not created equally. If you are comparing performance amongst funds, you should measure them among asset class and industry level. A mutual fund specializing in technology sector growth equities is not equally comparable to an investment-grade sovereign bond fund. Performance of asset classes changes along industry lines and investment categories. If you want to compare a fund’s ability to perform, relate it among its asset class. For mutual funds which can be closely tied to an index, you can compare the fund with its index or benchmarks of highly similar performance.

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Past Performance

Past Performance

The past’s performance is not always reliable. Many investors sink their cash in last year’s top mutual fund listed in a magazine or on a financial news channel. You should not be one of them. You need to realize that when the best performance is listed it is last year’s performance. It did this capitalizing on opportunities which were already offered and expired. There is no guarantee the fund can continue to do this in the present year. Investors who place their money in peaking or peaked funds may be in for a disappointment if the fund levels off toward industry averages.

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Consistent Performance

Consistent Performance

You should favor stable mutual funds over highly volatile mutual funds. A mutual fund which is highly volatile could be very high when you need to sell. The downside is that it could also be very low. A fund which has high amounts of volatility is somewhat unpredictable. During upward markets, it will be among your strongest performers, but it will be among your biggest losers in downturns. A highly volatile fund may provide little benefit for you by the time you desire to cash out.

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Mutual Funds & Cash Drag

Mutual Funds & Cash Drag

Each mutual fund keeps a redemption pool usually ranging from roughly two to five percent of total assets. This pool lets the fund to pay exiting investors without selling investments to meet redemptions. New investors to the fund refill the pool in the short term. When refilled, fund managers place money into new investments. Unfortunately, these pools also impact performance under certain specific conditions by creating Cash Drag.

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Mutual Funds Benefits

Mutual Funds have many inherent benefits that aren’t available to purchasers of other investments. Mutual fund investors gain from professional managers, who instantly diversify their holdings by purchasing several hundred investments. Many times, these funds will allow you to invest a little money at a time through an automated investing program. This program cost averages automatically, and if available you should consider it. Due to the diversification, you save far more in commissions than if you dollar cost average on your own.

Diversification

Diversification

The largest financial benefit of a mutual fund is the instant diversification that occurs. Mutual funds often own hundreds of different investment instruments. Your investment’s performance is spread among these instruments. If a single investment flops, there are hundreds of others which can compensate for that loss of performance.

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Unit Cost Averaging

Unit Cost Averaging

Mutual funds are great for unit cost averaging thanks to their diversification abilities. You can use a mutual fund’s automated withdrawal program to engage in this method without manual entry. Unit cost averaging is often denoted by the currency, such as “dollar cost averaging”. Unit Cost Averaging occurs when you invest a little bit of money at a time. This process varies the prices for your purchases since you are buying at many different market points.

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Professional Investment Management

Professional Investment Management

All mutual funds have managers, but management’s purpose changes for index and active funds. An index fund has a management team that fills more clerical roles. These funds track and exactly emulate indexes, benchmarks, or exchanges. Management simply records the index’s changes and applies those same changes to their index fund. Active fund management teams must research, identify, track, and invest in various firms qualifying the objectives of the fund. They determine when to buy or sell each investment. Your return depends entirely on the ability of the fund’s managing team.

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Mutual Funds Downsides

All investments have downsides, and mutual funds are included. There are some potentially serious flaws that you must be aware are created by the structure of funds. They don’t outweigh the potential benefits provided by mutual funds, but being oblivious to these issues could cause you serious unforeseen headaches. The biggest issues with mutual funds are their Daily Liquidity, Minimum Fee, and Loss of Control. A potential issue deriving from the loss of control is fund overlapping, which arises when multiple funds you own invest heavily in the same assets.

Daily Liquidity

Daily Liquidity

Trading limitations are a large downside to investing in mutual funds. Net Asset Value is only updated at the end of each day, when the investments in the fund have their finalized day prices. Since NAV is the basis for pricing and is only updated at end of the day, funds only honor buy and sell orders when prices are static. Mutual funds will allow you to trade daily after markets have closed. Equity shares allow you to liquidate your holdings in as little as 10 to 15 minutes if you have a partner to the trade.

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Minimum Mutual Fund Balance

Minimum Mutual Fund Balance

A mutual fund requires a specific amount of money to enter the fund, known as the Minimum Mutual Fund Balance. This fee is determined by the fund’s management and indirectly controls the amount of investors that can make an investment. These minimum fees range from an easy $50 up to tens of thousands of dollars, depending on the fund. This may not be seen as a negative but any entry limitation to an otherwise desirable investment counts as a downside.

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Asset Selection Loss

Asset Selection Loss

The benefit of professional management has a downside which cannot be negated by researching their skill level. This is the loss of control over investments owned by funds. You have elected to place your finances in the hand of an investment team. This team is obligated to act in your best interests but it is not required to engage your suggestion, opinions, or requests.

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Portfolio Overlap

Portfolio Overlap

A downside of investing in funds is investment overlaps, extending from a lack of control over investments within a fund. Fund overlap occurs when multiple funds within your portfolios own the same investment. A fund that invests worldwide may hold some of the same bonds as a domestic mutual fund and emerging market funds. A generalized domestic fund may own some of the same equities as several sector funds. These are fund overlaps. It also occurs if you own an individual investment that your mutual funds also own.

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Mutual Fund Taxation

Most companies are taxed, but mutual funds are an exception to the rule. All taxation is passed directly to fund shareholders. The mutual fund does not pay taxation on profits made buying or selling investments. You will pay a tax on each profit, keyword each. This applies for every single investment in the fund, and not simply for the Net Asset Value. If they buy a security and sell it for gains, the tax on the profit incurred is paid for by you even if the NAV of the fund is lower than it was when you entered the firm. It is possible that you will pay capital gains taxation even in a year where you’ve suffered losses, even if you haven’t withdrawn from the investment. This will increase your perceived losses.

Mutual Funds

International Economic Analysis:

  • Major Currency Economic Summaries
  • Performance of Major Imports and Exports
  • Mandates of Central Banks versus Expectations
  • Performance Indexes of Major Economies
  • Economically Correlated Currency Projections
  • Large Funds Currency Sentiment Readings
  • List of Technical Indicators to Look For
  • Occasional: Foregin Exchange Technicals Markups

Mutual Funds

American Markets Analysis:

  • Summaries of American Economic Structure
  • Performance of Major
  • Imports/Exports
  • Federal Reserve Mandate versus Expectations
  • Performance Indexes of U.S Economy
  • Economically Correlated U.S Dollar Projections
  • Large Trading Fund Index Sentiment Readings
  • Market Wide Earnings Versus Valuations
  • Fundamental Ranking of U.S Business Sectors
  • Best and Worst Future Consensus Estimates
  • Occasional: Firm Fundamental Strength Report
  • List of Technicals to Look for While Trading

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