chapter 12

© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 5th Ed., Prentice Hall Inc.

Personal Finance:Personal Finance:An Integrated Planning ApproachAn Integrated Planning Approach

Winger & FrascaWinger & Frasca

Chapter 12Chapter 12 Mutual Funds and Other Pooling Mutual Funds and Other Pooling

ArrangementsArrangements

http://www.prenhall.com/winger/


Major TopicsMajor Topics

Mutual Funds Investment Trusts Limited Partnerships and Investment Clubs Constructing and Maintaining Your

Personal Portfolio


Types of Pooling ArrangementsTypes of Pooling Arrangements

Mutual Funds– Closed End

– Open End Investment Trusts

– Unit Investment Trusts (UITs)

– Real Estate Investment Trusts (REITs) Limited Partnerships Investment Clubs


What Is A Mutual Fund?What Is A Mutual Fund?

Pools the Funds of Many Individuals to Invest in Stocks, Bonds, and Many Other Types of Assets

A Fund’s Net Asset Value (NAV) is the Total Value of All the Assets the Fund Owns (minus any liabilities) Divided by the Number of Shares Issued by the Fund


Fund X’s NAVFund X’s NAV

Company # of Shares Price per Total

Owned Share Value

IBM 100 $120 $12,000

Xerox 100 80 8,000

GM 100 70 7,000

Value of the fund’s portfolio $27,000

Number of shares issued 1,000

Fund X’s NAV $ 27.00


Load Versus No-Load FundsLoad Versus No-Load Funds

A Load is a commission paid to buy or sell fund shares– Loads range from 1% to over 9% of NAV– No-load funds have no commission to buy shares

(called a “front-end” load), but some charge a commission to sell (called a “back-end” load)

There is no evidence showing that load funds do better than no-load funds


Open-End FundsOpen-End Funds

Most Popular Type of Fund– They Advertise Extensively to Attract Investors– Large Funds Include Fidelity, Vanguard

You Can Deal Directly with the Fund to Buy or Sell Shares– Completing an Application Form is Easy– Shares Are Purchased/Sold at NAV (Plus a Load, if

Applicable)– You Can Use Many Fund Services


Closed-End FundsClosed-End Funds

Shares Trade in the Securities Markets– You Trade Shares As You Would the Shares of Any

Company, such as Intel– While You Do Pay a Broker’s Commission, There

Are No Loads Shares Trade at Premiums or Discounts to NAV

– Discounts Can Be Attractive; In Effect, You Buy $1.00 Worth of Securities for Less than $1.00


Fund ObjectivesFund Objectives

Type of Fund Objective

___________ _______________________________

Growth Price Appreciation over Time

Income High Current Return

Balanced Good Current Return with some Growth

Money Mkt. High Liquidity and Returns Better than

Bank Returns

Maximum Exploit Opportunities to Earn Very High

Appreciation Returns


Fund Objectives,ContinuedFund Objectives,Continued

Type of Fund Fund Objective

____________ _______________________________

Sector Invests in Only One Industry

International Earn Returns in Countries outside the

United States

Global Earn Returns in both the United

States and Foreign Countries

Index Earn Returns Equal to a Market Index

Returns


Mutual Fund ServicesMutual Fund Services

Reinvestment Plans– Can Reinvest Dividends and Capital Gains

Transactions by Telephone and Internet Fund Switching within a Fund Family

– Can Sell Shares of One Fund and Reinvest in Shares of Another Fund

– Be Careful of Loads Adaptability to IRAs


Selecting a Mutual FundSelecting a Mutual Fund

Evaluate Performance Review the Fund’s Current Portfolio Examine Expenses and Turnover Review Evaluations in Popular Magazines

and Newspapers Consult a Professional Evaluation Service,

such as Morningstar


Performance MeasurementsPerformance Measurements

Growth of $1,000 over Time– Example: a cumulative total return of 259.45% means

that $1,000 invested 10 years ago has earned $2,594.50 and the investment is now worth $3,594.50

– Assumes that All Dividends Are Reinvested as They Are Earned Each Quarter

Average Annual Total Return (AATR)– Expresses the Cumulative Return as a Yearly Average:

13.65% for the Above


The Risk-Adjusted Rate of Return The Risk-Adjusted Rate of Return (RAROR)(RAROR)

Adjusts a Funds AATR by Its Beta Value and Compares this Adjusted Return to the Overall Market Return

RAROR = (AATR/Beta) - S&P 500 ReturnExample: AATR = 13.65%, Beta = 0.86, S&P 500

Return = 14.39%

RAROR = (13.65%/0.86) - 14.39%

= 15.87% - 14.39%

= + 1.48%


Interpreting RARORsInterpreting RARORs

A Positive RAROR Indicates Good Fund Management

A Negative RAROR Indicates Poor Fund Management

It is Important to Have + RARORS Consistently Over Time--Do Not Rely Too Heavily on One Year’s Number


Other Evaluation ItemsOther Evaluation Items

Review the Fund’s Current Portfolio– Is There Adequate Diversification?

Review the Fund’s Operating Expenses– Usually Expressed as a % of Net Assets– Small %s Are Desirable

Examine the Portfolio Turnover %– Turnover % Measures the Trading Frequency:

High Numbers = Much Trading


Fund EvaluationsFund Evaluations

The Popular Press– Wall Street Journal--Each Friday Issue

– Money Magazine

– Business Week

– Forbes Professional Evaluations

– Morningstar is An Example

– You Pay for this Service BUT Check Out Morningstar’s Web Site for Free Info


Unit Investment TrustUnit Investment Trust

Similar to an Open-End Fund– Trust Units (Shares) Are Purchased from and Redeemed

by the Fund Originator– Redemption is at Current Market Value

Major Difference– A Trust’s Portfolio is Unmanaged; i.e., Once Established

It Is Left Virtually Unchanged– This Leads to Very Low Operating Costs– However, UITs Have Loads


Creation of a UITCreation of a UIT

Trust Originator

Buys a Portfolio of Bonds

and Sells Trust Units to Individual Investors

Investor A Investor B Investor C

Who May Hold Their Units to Maturity or

May Sell Back to Originator--at Current Market Value


Exchange Traded FundsExchange Traded Funds

UITs that trade in the securities markets, similar to closed-end funds

Relatively fixed portfolios– Based on broad market (QQQs, Spiders,

Diamonds, others)– Based on market segments (Industry ETFs,

Holders, others)


ETF Advantages (Disadvantage)ETF Advantages (Disadvantage)

Positions can be taken quickly, just as with any individual stock

Shares can be purchased on margin Very low expense ratios Tax advantage insofar as investors can

avoid capital gains by simply not selling But, commissions must be paid on trades


Real Estate Investment Trusts Real Estate Investment Trusts

Similar to a Closed-End Fund– Equity per Share (EqPS) of a REIT is Similar to NAV and

Calculated as Follows:

(Assets - Liabilities)/REIT Shares Outstanding

Types of REITs– Equity Trust: Invest in Rental Properties

– Mortgage Trust: Invests in Mortgages

Investment Appeal: Easy Way to Include Real Estate in a Portfolio


Limited Partnerships (LPs)Limited Partnerships (LPs)

Formed by:– General Partner Who Runs the Business– Limited Partners Who Put Up the Money

Invest in a Various Activities, Such As:– Real Estate– Energy Programs– Equipment Leasing


Limited Partnerships (LPs)Limited Partnerships (LPs)

Unique Feature is the Pass Through of Business Profits and Losses to the Limited Partners

Losses Can Have Significant Advantages if Used to Offset Other Taxable Income

However, Current Tax Code Severely Limits Such Deductions

Making LPs an Undesirable Vehicle for Most Investors Moreover, LP Interests Cannot be Sold Easily, Making

Your Investment Highly Illiquid


Investment ClubsInvestment Clubs

Characteristics– Frequent Meetings, Usually Monthly

– Low Monthly Contributions, $25 - $50

– Members Do Research on Specific Stocks Advantages

– Diversification

– Help with Investing Workload

– Fun and Fellowship


Investment ClubsInvestment Clubs

Disadvantage: – Too Much Fun, Not Enough Research


Portfolio Construction: Portfolio Construction: Aggressive InvestorAggressive Investor

Characteristics– Risk Tolerance: High– Return Preference: Future Return– Priority of Specific Future Goals: Not Strong

Investor Types– Persons with No Dependents– Wealthy Investors


Portfolio Construction: Portfolio Construction: Cautious InvestorCautious Investor

Characteristics– Risk Tolerance: Low– Return Preference: Future Return– Priority of Specific Future Goals: Very Strong

Investor Types– Anyone with Dependents– Investors Planning Retirement– Investors Planning a Major Purchase


Portfolio Construction: Portfolio Construction: Investor Who Needs IncomeInvestor Who Needs Income

Characteristics– Risk Tolerance: Moderate– Return Preference: Current Return– Priority of Specific Future Goals: Moderately Strong

Investor Types– Retirees– Persons with Dependents to Support– Persons with No Major Future Expenses


Investment SelectionInvestment Selection

Aggressive Investor– 100% Stocks: 1/3 Large Company, 1/3 Small

Company, 1/3 International Cautious Investor

– 30% Large Company Growth Stocks, the Balance in Bonds, including Zero-Coupon

Investor Who Needs Income– 50% High-Quality Corporate Bonds, 25% Medium-

Quality Corporate Bonds, and 25% Income Stocks


Maintaining a PortfolioMaintaining a Portfolio

Stocks Bonds(1) Amount Invested

Initially $10,000 $10,000

(2) Current Market

Values 15,000 9,000

(3) Adjustment with

Constant Ratio Plan * - 3,000 + 3,000

(4) Adjusted Balances 12,000 12,000

____________

* A Variable Ratio Plan Would Sell More Stocks and Buy More Bonds


401(k) Plan Considerations401(k) Plan Considerations

Don’t Reject Participation Diversify Broadly Using a Variety of Funds Coordinate Out-of-Plan Investments with

In-Plan Investments Don’t Try to Time the Markets, Even

Though Gains Are Not Taxed Avoid Excessive Conservatism


NextNextChapter 13Chapter 13

Property and Liability InsuranceProperty and Liability Insurance

chapter 12

Economy & Finance

fund shares

funds portfolio

fund evaluations

internet fund

fund family

funds aatr

funds current portfolio

openend funds